The current macro environment is characterized by a striking mix of signals, with the economy appearing stable on the surface but showing signs of slowing beneath. This situation contrasts sharply with late 2022, when the prevailing consensus predicted an imminent recession. At that time, we emphasized the importance of consumer spending, supported by pent-up savings and a robust labor market. With consumer spending accounting for approximately two-thirds of GDP, our belief was that as long as the American consumer remained willing and able to spend, a recession could be avoided—and that proved to be the case.
However, as we enter the current period, economic indicators are less positive. Income growth has begun to decelerate, job growth is waning, and both hiring and quits’ rates have dropped to cycle lows. These developments indicate that finding employment is becoming increasingly difficult, yet the dominant narrative remains one of growth. In our view, this optimism largely hinges on expectations of sustained earnings growth, deregulation, and increased government efficiency aimed at reducing expenditures. While these outcomes are certainly possible, the current expectations may be overly optimistic. We believe this disconnect heightens concerns about the market’s susceptibility to downside risks.
Adding to this complexity is the tight monetary policy environment. The Federal Reserve’s stance appears, in our view, overly restrictive, particularly evident in credit-sensitive sectors such as housing, where activity is declining due to higher interest rates. In September, the Fed seemed proactive in its approach, but now it appears hesitant to adjust rates, even as core Personal Consumption Expenditures (PCE) has remained below their target for two consecutive months. This reluctance likely stems from uncertainties surrounding fiscal policy, especially with significant changes being proposed by the Trump administration.
Recent headlines have been dominated by President Trump’s announcement of a hard deadline—March 4th—for imposing tariffs on Mexico and Canada, alongside a doubling of the existing 10% tariff on Chinese imports. With both the magnitude of tariffs and their duration unknown, it is difficult to forecast the impacts they will have on supply chains and inflation expectations. After navigating a global supply shock due to COVID-19 that had previously ignited inflation, it is understandable that the Fed would adopt a cautious, wait-and-see strategy. Nevertheless, the continued elevation of interest rates poses risks to both consumer spending and overall economic health.
As the Fed maintains its current rate levels without further cuts, they run the risk of passively tightening. In our view, the longer this persists, the greater the risk of an economic slowdown becomes. In conclusion, while the consumer has so far supported the economy, the evolving landscape of employment, monetary policy, and fiscal policy suggests that we must remain vigilant. The mixed signals in the market necessitate a careful assessment of potential vulnerabilities as we move forward.
By Veronica Fulton, CFA, Associate Portfolio Manager
Originally published March 3, 2025
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