It is rare that in a payroll week the main focus of the conversation is not the US labor market, but tariffs are certainly stealing the thunder nowadays. The week began with imminent 25% tariffs on Mexico and Canada…which were then both delayed for 30 days. 10% tariffs on China went ahead. And the week ended with indications from President Trump that we would announce “reciprocal tariffs” in coming days, presumably affecting many, if not all, trading partners. Suffice to say, some form of (further) tariff increases is coming, even if we do not yet know exactly when and how sizable. The consumers, however, are already responding: one-year inflation expectations in the Michigan Consumer Sentiment survey surged a full percentage point in the preliminary February reading, hitting 4.3%. Since the start of 2023, there had been only two higher readings, in November and April 2023 (at 4.5% and 4.7%, respectively). This will undoubtedly be seen as a problem by the Fed, even if the final reading shows a less extreme acceleration. Over the last three months there has been an undeniable move higher in short term inflation expectations. Given all that is transpiring with tariffs, this is unlikely to settle back quickly.
The Fed had already been telegraphing that the resilient labor market (and overall economy) is allowing them the luxury of waiting before easing again. This data tells them not only that they can wait, but that they should, wait. It is a bit of an unfortunate turn of events as core PCE seems set for a step down in January/February, and that could have opened a door for a March rate cut. Even with that improvement (which we still expect to see) that door now appears shut. Moreover, it is unlikely for it to reopen in short order, so it is understandable that markets have trimmed their expectations. The FOMC line of thinking—or at least Chairman Powell and Governor Waller’s—appeared to be that they would like to cut again if they could. The new dynamic in play likely change that inclination to cutting “ if they must. That “must” signal would have come from the labor market, but it certainly did not come in the January report (more below). Given the timeline, our call for three Fed rate cuts this year, is on thin ice. We are not changing it yet, however, as we want to see how employment behaves over the next couple of months.
The January employment data was solid, with upward revisions to prior months offsetting a modest downside surprise in the headline. The underlying fundamentals of the labor market remain strong, and the further one-tenth decline in the unemployment rate (to 4.0%) suggests that the clear softening that preceded the Fed’s 50-bp cut in September has reversed somewhat. Non-farm payrolls rose 143k (vs 176k consensus) and prior two months were revised up by 100k The annual benchmark revision to the March 2024 level turned out to be lower than what the BLS had initially projected at -598k (initially reported as -818k). New population estimates were incorporated into the data that better encapsulate migration flows. This is a space everyone is watching carefully for reversions that could re-ignite wage pressures. Average hourly earnings jumped 0.5% m/m in January, and persistence at this level would be problematic. However, we see the January increase as reflecting weather-related composition effects and a late survey date.
