
Katie Nixon, CFA, CPWA®, CIMA®
Chief Investment Officer, Northern Trust Wealth Management
A tariff-rate reprieve between the U.S. and China this week was greeted by investors as unequivocally positive, though myriad uncertainties remain amid ever-changing trade policy news that is rendering data difficult to assess. In this Weekly Five, we discuss our views on the impact of prolonged uncertainty on growth and inflation, Fed Chair Powell’s latest remarks, and probability of recession.
What is your view on the temporary trade agreement reached between the U.S. and China, including the implications for growth risks in the U.S.?
Tariff de-escalation continues, with the announcement early in the week that the U.S. and China have reached a temporary trade agreement. The deal, effective on May 15, will remain in place for a 90-day period and essentially reduces the average tariff rate on Chinese imports from 145% to 30%. China, in turn, reduced the tariffs on U.S. goods put in place as retaliation after President Trump’s Liberation Day from 125% to 10%, some of the other trade-related restrictions on rare-earth mineral exports, and committed to continuing to address the fentanyl crisis.
This is an important step in stabilizing U.S./China relations, and, importantly, both sides are explicitly denying any desire to “decouple.” However, there are significant issues that remain to be reconciled, and the 90-day period is a truce that may prove temporary if broader issues are not addressed. That said, progress has been made — that is an unequivocal positive and has been greeted as such by financial markets. Wall Street strategists and economists alike have viewed the news as constructive and have reduced the odds of a U.S. recession. We continue to maintain our view of the probability of a recession at roughly 50%, and note that there will be consequences to the prolonged period of economic uncertainty on both growth and inflation fronts.
When do you expect that tariff-induced inflation will begin to have a more meaningful impact on U.S. consumers?
It is clear that the impact to consumers from increased tariffs will be felt soon. In a statement following the release of 1Q earnings results, Walmart plans to raise prices this month due to increased costs, with CFO John David Rainey recently saying, “The magnitude and speed at which these prices are coming to us is somewhat unprecedented,” and “the full impact of the trade war on consumers is yet to come.” The company also declined to offer forward guidance on earnings given the heightened uncertainty.
It is estimated that nearly 50% of the U.S. population shops at Walmart in-store or online, so the impact of these higher prices is anticipated to be broad. This threatens to reverse the meaningful progress in inflation that has been reflected in some of the recent data, specifically April CPI, as both headline and core consumer inflation surprised to the downside. Given the supply constraint environment we anticipate as a result of increased tariffs, we can anticipate goods inflation will rise — and disinflation in the goods sector has been a major contributor to the decline in overall inflation. We maintain our view that inflation will prove stickier in the next several months.
The Weekly Five
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How is the resilient jobs market supporting consumer spending and broader economic growth?
We continue to monitor conditions in the labor market closely, recognizing that wages are supporting consumer spending despite the overall feeling of economic uncertainty reflected in household survey data. This week’s initial jobless claims were unchanged at 229K, with continuing claims remaining within a relatively tight range at 1.88 million. Is a resilient labor market translating to robust consumer spending? The answer is: It depends.
As with a lot of economic data, recent news has been noisy to say the least, as both businesses and households try to navigate the ever-changing, always challenging tariff news. Consumers appear to have pulled forward demand into March under the assumption that higher prices were on the way, and retail spending in March rose the most in two years. The April data suggested a bit of payback, and while the 0.1% headline gain was better than expected, when we look beneath the surface and exclude some of the more volatile items, we saw a contraction of -0.2%. We expect the data will continue to be difficult to assess as the tariff bobbing and weaving continues; however, we do anticipate that jobs growth will slow as we get to the second half of 2025, driving a softness in retail sales and economic growth.
What is the state of the budget reconciliation bill in Congress, and how are bond markets reacting?
After working its way through Congress this week, the “One Big Beautiful Bill” met a setback today when the House Budget Committee voted down the reconciliation bill. Conservative Republicans have been vocal in dissent, and President Trump is engaging directly and indirectly to garner support.
A sticking point appears to be that the Senate’s bill uses a “currency policy baseline,” which does not re-set the budget to pre-2017’s passage of the TCJA and, effectively, won’t count the cost of extending that bill as contributing to the deficit. The House instructions allow for up to $2.8T in net deficit increases, with $4.8T in gross borrowings offset by $2T in spending cuts. The House Ways and Means Committee passed its portion earlier this week, with provisions costing $3.8T over 2025-2034, including the extension of the TCJA and several new provisions.
We are watching carefully the bond market reaction as the reconciliation process evolves, and with the 10-year Treasury yield breaching 4.5% mid-week, it is possible that concerns regarding prolonged deficit spending driving an even wider budget deficit are being reflected in a higher term premium — the additional return investors in U.S. Treasury bonds require to hold U.S. debt. These higher-for-longer Treasury yields have direct influence over the cost of corporate borrowing and, importantly, on mortgage rates. The average rate on a 30 year mortgage today sits at 6.81%, down from the rate a year ago of just over 7%, but an increase from where we started the month. Housing remains a weak spot in the U.S. economy as affordability is an acute challenge. According to the S&P CoreLogic Case-Shiller index, national home prices are 39% higher today than they were in 2019. When you add the increased cost of financing — the 30 year mortgage rate in 2019 was 4.13% — buying a home is even further out of reach for many Americans.
How have markets reacted to the macro and policy news this week?
This week, Fed Chair Jerome Powell warned, “We may be entering a period of more frequent, and potentially more persistent, supply shocks — a difficult challenge for the economy and for central banks.” We would add that this type of environment presents unique challenges for households and investors as well. For the economy, supply shocks are the worst of both worlds: growth headwinds and inflationary tailwinds. For central banks — particularly those with a single mandate of maintaining price stability, such as the European Central Bank, Bank of England, and Bank of Japan — a focus on inflation will require tighter policy, may exacerbate a growth slowdown, and could drive a recession.
For the U.S., the dual mandate provides some flexibility; however, today’s central bank has been extremely focused on getting us back to an environment of price stability — and a future characterized by unpredictable supply shocks will keep that element of the dual mandate front and center. It will be a policy dilemma for the U.S. and a policy constraint for the other developed market central banks. For households, losing real purchasing power will lower standards of living, and the very environment of uncertainty may create a self-fulfilling feedback loop of lower growth. For investors, it is a reminder that portfolio diversification is the best defense: We continue to recommend robust diversification in Risk Asset portfolios, including global equity, but also real assets such as public real estate, natural resources and infrastructure. We also recommend an allocation to Treasury Inflation Protected Securities (TIPS) as a hedge against inflation risk and as a core component to a Risk Control allocation.