Fed is concerned about hard landing on Trump policy tantrum

·       DJ-30 slips on subdued guidance by Walmart, the bellwether of the US economy (consumer spending)

·       Apart from the Trump tariffs tantrum, the market is now also concerned about growing delinquencies in subprime lending assets

·       Tech-savvy NQ-10 is being boosted by AI Chip optimism, but the risk of excessive over-valuation and AI and Crypto bubble may be imminent (like the dot-com bubble in the 2000s)

·       The latest FOMC minutes show Fed is quite cautious about Trump policy uncertainty, and may close the QT by Q2/Q3CY25

·       Fed is also discussing the next QE format in a different mix; Fed may cut in June and December’25

In the last few weeks, since Trump 2.0 inauguration on 20th January 2025,  the US Federal Reserve (Fed) has expressed growing concerns about the potential for a U.S. economic "hard landing"—a scenario where efforts to control inflation lead to a recession amid Trump 2.0 policy tantrum and uncertainty. The Fed is quite concerned about Trump’s aggressive tariffs, deportations firings of Federal employees, and conservative immigration policies, which may affect the goldilocks nature of the US economy and a potential soft landing scenario.

Now after the first 30 days of Trump 2.0, almost all Fed officials, including known doves are concerned that Trump’s bellicose policies may cause higher unemployment, labor market tightening, wage inflation spiral, and eventually reignite inflationary pressures, disrupt economic growth, and complicate the Fed's ongoing mission to achieve a "soft landing"—cooling inflation without tanking the economy.

The latest FOMC minutes (January 28-29, 2025 meeting) also, highlight this tension. FOMC officials noted that while the economy has shown resilience, with unemployment steady at 4.1% as of late 2024 and GDP growth estimated at 2.5% for Q4 2024, the Trump administration's plans could shift the outlook. Trump's proposed aggressive tariffs on almost all major trading partners including allies could drive up the cost of living as US importers/producers/retailers may not hesitate to pass on additional costs this time to test customer acceptability and consumption behavior.

The US core disinflation is almost stalled in Q2CY24 due to various reasons apart from the fact that the last mile of disinflation is always tough. Even Trump or no Trump policy uncertainty, the US core inflation (PCE+CPI) may not fall to the Fed’s target of 2.0% on a sustainable basis before late 2026 from present levels of around 3.2%.

Also Trump’s immigration restrictions, meanwhile, might tighten labor markets, especially in sectors like agriculture and hospitality, pushing wages higher and adding to price pressures. There are almost 12 million so-called illegal immigrants in the US, who work in various informal sectors at comparatively cheaper rates with cash payment. The US may face an acute labor shortage in these sectors if Trump indeed deports a major chunk of these illegal or undocumented immigrants without any alternative arrangements. The latest Fed staff projections (SEP) from December 2024 already suggested slightly lower GDP growth and a marginally higher unemployment rate under preliminary assumptions about these policies.

The Fed's response has been cautious. After cutting rates by 100 basis points in late 2024, including a quarter-point cut in December, it paused in January 2025, reflecting a "finely balanced" decision. Some officials even argued against further cuts, citing stalled inflation progress and rising risks from Trump’s agenda. Even known doves like Chicago Fed President Goolsbee, once a vocal advocate for rapid rate reductions, signaled a slower approach, emphasizing the need to assess how recent cuts and new policies play out. Businesses, too, are wary—surveys from the Fed’s Beige Book in early January 2025 showed optimism tempered by fears of trade and immigration policy disruptions.

Trump’s public pressure hasn’t helped. On January 24, 2025, he demanded rate cuts, claiming superior monetary policy insight—a throwback to his first term’s "tantrums" against Fed Chair Powell. This rhetoric raises the specter of a clash over the Fed’s independence, which Powell has staunchly defended. If Trump’s policies fuel a "policy tantrum"—market volatility or economic instability—the Fed might face a dilemma: ease rates to cushion growth, risk inflation, or hold firm and risk a hard landing. But Trump may be now trying to target US bond yield directly by issuing fewer bonds and monetizing Gold to pay a part of the huge US public debt of almost $40 trillion and a part of fresh deficit spending.

In January, the Federal Open Market Committee (FOMC) unanimously decided to maintain current interest rates, for the next few months at least till H1CY25, partly due to the assessment of the inflationary impact of Trump 2.0 tariffs and immigration policies. The minutes from this meeting highlighted "upside risks to the inflation outlook," specifically citing potential changes in trade and immigration policies as contributing factors.

President Trump's recent announcement of a 25% tariff on imports of automobiles, pharmaceuticals, and semiconductors, set to take effect on April 2, has further intensified these concerns. These tariffs are expected to affect major trading partners, including Mexico, Japan, and Canada, potentially disrupting global supply chains and increasing costs for consumers.

Since taking office on January 20, he has already launched 10% tariffs on China, 25% tariffs on steel and aluminum imports, and planned for reciprocal tariffs targeting major US trading partners. Separately, China criticized Trump’s tariffs at a WTO meeting Tuesday, citing inflation risk, market distortions, and a possible global recession, and urging Washington to withdraw its moves and engage in multilateral dialogues. Trump 2.0 Chinese tariffs of 10% and counter-tariffs are now active. Trump is now even thinking of a Phase-2 US-China trade deal with much more Chinese buying commitments than the 2020 US-China Phase-1 trade deal just before the COVID shock.

Economic Concerns and Tariffs

Inflation Risks: The Fed's recent meeting minutes indicated that FOMC participants are worried Trump's tariffs may "impede the disinflation process," potentially leading to higher consumer prices. This concern stems from the possibility that businesses might pass increased costs from tariffs onto consumers, complicating the Fed's efforts to manage inflation effectively.

Interest Rate Decisions: The Fed opted to maintain interest rates steady in Q1CY25 due to these inflation concerns linked to tariffs. This decision reflects a cautious approach as they navigate the uncertain economic landscape shaped by Trump's policies. Fed Chair Powell emphasized that the central bank is not rushing to make further cuts until there is more clarity on the economic implications of Trump 2.0 policies.

Economic Growth Outlook: While some economists predict a "soft landing" for the U.S. economy in 2025, characterized by stable growth and manageable inflation, others warn that persistent inflation pressures could lead to a stagnation scenario where economic growth stalls without a clear resolution. The Fed's challenge will be balancing support for economic activity while controlling inflation, which currently hovers above their target rate of 2%

Political Dynamics

Trump's return to political influence comes with expectations of aggressive economic policies, including potential tariff increases on various goods from key trading partners like China and Mexico. This has led to speculation about how his administration might pressure the Fed for more aggressive monetary policy adjustments, reminiscent of his first term. The uncertainty surrounding these policies creates additional challenges for the Fed in forecasting and responding to economic conditions. But Fed Chair Powell has already clarified many times including in the semi-annual Congressional testimony last week that the Fed is responsible for monetary policies, not fiscal, but is free to take required monetary policies to maintain the dual mandate of minimum price stability and maximum employment.

Highlights of Minutes of the Federal Open Market Committee, January 28-29, 2025:

·       The vast majority of participants judged risks to mandate roughly balanced

·       Few believe Fed Funds may not be far above the neutral level

·       Some participants cited potential changes in trade and immigration policy as having the potential to hinder the disinflation process

·       Inflation risks skewed upward

·       Fed wants further progress on inflation before adjusting rates

·       The Fed can maintain policy at a restrictive level if the economy is strong

·       Several participants suggest halting or slowing balance sheet reduction pending debt ceiling resolution

·       Two participants believe the risks of achieving an inflation mandate outweigh the risks of the employment mandate

·       Most participants judged risks to dual mandate objectives were roughly in balance

Full text of relevant part of January’25 FOMC Minutes:

Staff Economic Outlook

The staff projection for economic activity was similar to the one prepared for the December meeting, with the output gap expected to narrow further until early next year and to remain roughly flat thereafter, and with the unemployment rate expected to remain close to the staff's estimate of its natural rate. For this projection, the staff had used the same preliminary placeholder assumptions for potential policy changes that were used for the previous baseline forecast and continued to note elevated uncertainty regarding the scope, timing, and potential economic effects of possible changes to trade, immigration, fiscal, and regulatory policies. The staff highlighted the difficulty of assessing the importance of such factors for the baseline projection and had prepared a number of alternative scenarios.

The staff's inflation projection was also essentially unchanged from the one prepared for the previous meeting. Inflation in 2025 was expected to be similar to 2024's rate, as the effects of the staff's placeholder assumption for trade policy put upward pressure on inflation this year. After that, inflation was projected to decline to 2 percent by 2027.

The staff continued to view the uncertainty around the baseline projection as similar to the average over the past 20 years, a period that saw a number of episodes during which uncertainty about the economy and federal policy changes was elevated. The staff judged that the risks around the baseline projections for economic activity and employment were roughly balanced. The risks around the baseline projection for inflation were seen as skewed to the upside because core inflation had not come down as much as expected in 2024 and because changes to trade policy could put more upward pressure on inflation than the staff had assumed.

Participants' Views on Current Conditions and the Economic Outlook

In their discussion of inflation developments, participants observed that inflation had eased significantly over the past two years. Inflation remained somewhat elevated, however, relative to the Committee's 2 percent longer-run goal, and progress toward that goal had slowed over the past year. Available data suggested that total PCE prices had risen about 2.6 percent over the 12 months ending in December and that, excluding the volatile consumer food and energy categories, core PCE prices rose 2.8 percent.

A number of participants remarked that current readings of 12-month inflation were boosted by relatively high inflation readings in the first quarter of last year, and several participants noted that cumulative inflation over the past 3, 6, or 9 months showed greater progress than 12‑month measures. Most participants commented that month-over-month inflation readings in November and December had exhibited notable progress toward the Committee's goal of price stability, including in some key subcategories. Many participants, however, emphasized that additional evidence of continued disinflation would be needed to support the view that inflation was returning sustainably to 2 percent.

Regarding the subcategories, housing services inflation, which had remained elevated for much of the previous year, had shown a decline, as had market-based measures of core non-housing services inflation. Several participants noted that some non-market-based services price categories, such as financial and insurance services, had shown less improvement, but a few also observed that price movements in such categories typically have not provided reliable signals about resource pressures or the future trajectory of inflation. Several participants observed that core goods prices had not declined as much on net in recent months compared with earlier in 2024.

With regard to the outlook for inflation, participants expected that, under appropriate monetary policy, inflation would continue to move toward 2 percent, although progress could remain uneven. Participants cited various factors as likely to put continuing downward pressure on inflation, including an easing in nominal wage growth, well-anchored longer-term inflation expectations, waning business pricing power, and the Committee's still-restrictive monetary policy stance.

A few noted, however, that the current target range for the federal funds rate may not be far above its neutral level. Furthermore, some participants commented that with supply and demand in the labor market roughly in balance and in light of recent productivity gains, labor market conditions were unlikely to be a source of inflationary pressure in the near future.

However, other factors were cited as having the potential to hinder the disinflation process, including the effects of potential changes in trade and immigration policy as well as strong consumer demand. Business contacts in a number of Districts had indicated that firms would attempt to pass on to consumers higher input costs arising from potential tariffs.

In addition, some participants noted that some market- or survey-based measures of expected inflation had increased recently, although many participants emphasized that longer-term measures of expected inflation had remained well anchored.

Some participants remarked that reported inflation at the beginning of the year was harder than usual to interpret because of the difficulties in fully removing seasonal effects, and a couple of participants commented that any increase in reported inflation in the first quarter due to such difficulties would imply a corresponding decrease in reported inflation in other quarters of the year.

Participants judged that labor market conditions had remained solid and that those conditions were broadly consistent with the Committee's goal of maximum employment. Payroll gains had averaged 170,000 per month over the last three months of 2024 and the unemployment rate had stabilized at a relatively low level.

Participants also noted that recent readings of indicators such as job vacancies, the quits rate, and labor turnover were generally consistent with stable labor market conditions. Participants anticipated that under appropriate monetary policy, conditions in the labor market would likely remain solid. Nonetheless, participants generally noted that labor market indicators merited close monitoring. Business contacts in a few Districts noted that they were expecting stable employment levels and moderate wage growth at their firms. A couple of participants noted that the upcoming benchmark revision to the payroll growth estimates by the Bureau of Labor Statistics could provide more clarity regarding labor market conditions.

Participants observed that the economy had continued to expand at a solid pace and that recent data on economic activity, and consumer spending in particular was, on balance, stronger than anticipated. Participants remarked that consumption had been supported by a solid labor market, elevated household net worth, and rising real wages, which had been associated in part with productivity gains.

Several participants cautioned that low- and moderate-income households continued to experience financial strains, which could damp their spending. A few participants cited continued increases in rates of delinquencies on credit card borrowing and automobile loans as signs of such strains.

With regard to the business sector, participants observed that investment in equipment and intangibles was strong over the past year, though it appeared to have slowed in the fourth quarter. Some participants noted that favorable aggregate supply developments—including increases in labor supply, business investment, and productivity—continued to support a solid expansion of business activity.

Many participants remarked that District contacts or surveys of businesses reported substantial optimism about the economic outlook, stemming in part from an expectation of an easing in government regulations or changes in tax policies.

In contrast, some participants noted that contacts reported increased uncertainty regarding potential changes in federal government policies. A couple of participants remarked that the agricultural sector continued to face significant strains stemming from low crop prices and high input costs.

A number of participants commented on the financial conditions bearing on spending by households and businesses. Participants generally saw it as important to continue to keep a close watch on such conditions and their potential effects on economic activity and inflation. Many participants noted that certain financial conditions had tightened over the past several months. For example, longer-term Treasury and corporate bond yields and mortgage rates had risen notably. A couple of participants commented that high equity valuations or low credit spreads were providing some support to economic activity.

In their evaluation of the risks and uncertainties associated with the economic outlook, the vast majority of participants judged that the risks to the achievement of the Committee's dual-mandate objectives of maximum employment and price stability were roughly in balance, though a couple commented that the risks to achieving the price stability mandate currently appeared to be greater than the risks to achieving the maximum employment mandate.

Participants generally pointed to upside risks to the inflation outlook. In particular, participants cited the possible effects of potential changes in trade and immigration policy, the potential for geopolitical developments to disrupt supply chains, or stronger-than-expected household spending.

A couple of participants remarked that, in the period ahead, it might be especially difficult to distinguish between relatively persistent changes in inflation and more temporary changes that might be associated with the introduction of new government policies. Participants pointed to various risks to economic activity and employment, including downside risks associated with an unexpected weakening of the labor market, a weakening of consumers' financial positions, or a tightening of financial conditions, as well as upside risks associated with a potentially more favorable regulatory environment for businesses and continued strength in domestic spending.

In their discussion of financial stability, participants who commented noted a range of factors that warranted monitoring. Several participants mentioned issues related to the banking system. A few commented that bank funding risks had lessened and that many banks had improved their ability to access the discount window; however, a couple observed that some banks had increased their reliance on reciprocal deposits, and that the stability of these deposits had not been tested in a time of stress.

Several participants noted that some banks remained vulnerable to a rise in longer-term yields and the associated unrealized losses on bank assets. Several participants also mentioned potential vulnerabilities at nonbank financial institutions or nonfinancial corporations to a rise in longer-term yields or to leverage in these sectors.

A few participants noted concerns about asset valuation pressures in equity and corporate debt markets. A few participants discussed vulnerabilities associated with CRE exposures, noting that risks remained, although there were some signs that the deterioration of conditions in the CRE sector was lessening.

Several participants commented on cyber risks that could impair the operation of financial institutions, financial infrastructure, and, potentially, the overall economy. Several participants commented on vulnerabilities in the Treasury market, including concerns about dealer intermediation capacity and the degree of leveraged positions in the market. The migration to central clearing was noted by a few as an important development to track in this regard.

In their consideration of monetary policy at this meeting, participants noted that inflation remained somewhat elevated. Participants also observed that recent indicators suggested that economic activity had continued to expand at a solid pace that the unemployment rate had stabilized at a low level; and that labor market conditions had remained solid in recent months. With the stance of policy significantly less restrictive than it had been before the Committee's policy easing over its previous three meetings, all participants viewed it as appropriate to maintain the target range for the federal funds rate at 4-1/4 to 4-1/2 percent. Participants judged that it was appropriate to continue the process of reducing the Federal Reserve's securities holdings.

In discussing the outlook for monetary policy, participants observed that the Committee was well-positioned to take time to assess the evolving outlook for economic activity, the labor market, and inflation, with the vast majority pointing to a still-restrictive policy stance. Participants indicated that provided the economy remained near maximum employment, they would want to see further progress on inflation before making additional adjustments to the target range for the federal funds rate. Participants noted that policy decisions were not on a preset course and were conditional on the evolution of the economy, the economic outlook, and the balance of risks.

In discussing risk-management considerations that could bear on the outlook for monetary policy, a majority of participants observed that the current high degree of uncertainty made it appropriate for the Committee to take a careful approach in considering additional adjustments to the stance of monetary policy. Factors mentioned by participants as supporting such an approach included the reduced downside risks to the outlook for the labor market and economic activity, increased upside risks to the outlook for inflation, and uncertainties concerning the neutral rate of interest, the degree of restraint from higher longer-term interest rates, or the economic effects of potential government policies. Many participants noted that the Committee could hold the policy rate at a restrictive level if the economy remained strong and inflation remained elevated, while several remarked that policy could be eased if labor market conditions deteriorated, economic activity faltered, or inflation returned to 2 percent more quickly than anticipated.

A number of participants also discussed some issues related to the balance sheet. Regarding the composition of secondary-market purchases of Treasury securities that would occur once the process of reducing the size of the Federal Reserve's holdings of securities had come to an end, many participants expressed the view that it would be appropriate to structure purchases in a way that moved the maturity composition of the SOMA portfolio closer to that of the outstanding stock of Treasury debt while also minimizing the risk of disruptions to the market.

Regarding the potential for significant swings in reserves over the coming months related to debt ceiling dynamics, various participants noted that it may be appropriate to consider pausing or slowing balance sheet runoff until the resolution of this event. Several participants also expressed support for the Desk's future consideration of possible ways to improve the efficacy of the SRF.

Conclusions:

Although the Fed generally talks about 2.0% PCE inflation as a price stability target, in reality, it maintains 1.5% core/total PCE inflation and 2.3% core/total CPI inflation; i.e. around 1.9% average inflation (PCE+CPI) targets, Congress has entrusted along with maximum employment 96.0-95.5% of the labor force; i.e. 4.0-3.5% headline unemployment rate. Fed will now try to bring down average core inflation from around 3.0% to 2.5% by keeping the unemployment rate at least around 4.0% by December’25 and then 2.0% core inflation and 3.5% unemployment rate by December’26 to achieve its mandate of maximum employment and price stability.

As US core inflation almost stalled in Q4CY24 at around +3.1% on average, while the unemployment rate remains stable at around 4.1% along with resilient Real GDP and PDPF growths around 2.8-3.0% on average, the Fed should have paused in December to asses more data and Trump policies on inflation and employment. But the Fed cut 25 bps in Dec’24 too (after September and November) to make up for previous policy mistakes and be able to be ahead of the curve despite core disinflation almost stalled in H2CY24, while the unemployment rate remains stable around 4.0% and economic activity remains resilient.

Despite unfavorable data, and Trump policy uncertainty Fed cut on 18th December’24 to catch up with synchronized global easing and also to keep differential with ECB, which cut -100 bps in 2024. Fed may have also made a policy mistake by not cutting rates by 50 bps in H1CY24 and thus cut an additional 50 bps in H2CY24 to catch up. 

In H1CY25, the Fed may also share some concrete plans to end the QT, which may be positive for UST and negative for US bond yields, USD. Fed is now cutting rates while doing QT, which is two contra monetary policy tools. As a result, bond yields remain elevated at around 4.50% and the real economy may not be getting the full effect of a 100 bps rate cut in 2024. The market usually discounts Fed rate cuts well in advance in line with regular Fed talks and official dot plots.

Thus Fed may close the QT first by June’25 at B/S size around $6.60-6.50T from present levels of around $6.89T. Fed may keep the B/S size around 22% of projected nominal GDP around $30T by 2025, which may be an ideal level for the Goldilocks nature of the US economy and may not cause another REPO/Funding market crisis as we have seen late 2019 under Trump and Powell-1.0.

Fed may first close QT by June’25 and then resume the rate cut cycle for 50 bps cumulative in 2025. Fed may provide a definitive plan to end the QT in its March’25 meeting and close the same by June’25 and cut rates by 25 bps each in June and Dec’25.

Trump is set to finalize tariff imposition after March’25; and if he is satisfied with Canada and Mexico's action to slow or prevent illegal immigration and drug trafficking, he may not impose tariffs on Canada and Mexico. But still, there will be immense tariff uncertainty with China, EU, India and other EM trading partners on reciprocal tariffs issues. Thus it may not be possible for the Fed to assess the actual impact of Trump tariffs tantrums and also immigration & deportations on the US economy. Also, Trump’s mass firings policy of Federal employees will have a direct and indirect impact on employment and headline unemployment may tick up towards the Fed red line of 4.5%.

Bottom line

Thus considering all the possible scenarios, the Fed may close the QT by Q2 or Q3CY25; the Fed will do the next QE (if required) in a different composition. And Fed may cut a cumulative 50 bps in 2025 (June and December 25) every alternate quarter.

Market impact:

On Thursday, Wall Street Futures slipped on Trump tariffs tantrum and fading hopes of a 50 bps cumulative rate cut in 2025 as the market is now expecting only a 25 bps rate cut in Dec’25, while June’25 odds dipped below 45%. The market may be also now anxious about the repetition of the 2007-08 sub-prime crisis.

On Thursday, Dow Jones (DJ-30) was dragged by the subdued guidance of Walmart amid the Trump trade war tantrum, deportations and mass Firings of Federal employees. Walmart is seen as the bellwether of US consumer spending, the backbone of the US economy.

On Thursday, the Dow Jones (DJ-30) dropped 1.01%, while the S&P 500 and Nasdaq Composite lost 0.43% and 0.47%, respectively. Walmart plunged, weighing on other major retailers like Target and Costco. Defense stocks like Palantir plunged after reports of potential Pentagon budget cuts and a new stock sale plan by its CEO.

On Thursday Wall Street was dragged by banks & financials, consumer discretionary, consumer staples industrials, communication services, materials, and techs, while boosted by energy, real estate, healthcare,  and utilities. Dow Jones (DJ-30) was dragged by Walmart, JPM, Goldman Sachs, Boeing (Trump irritated about his new Airforce One delivery delay and instructs Musk for an audit), American Express, Salesforce, United Health (DOJ may probe its medical billing practices),  Amazon, Visa, Caterpillar and Walt Disney, while boosted by Merck, Amgen, Verizon, J&J, Chevron, NVIDIA, Microsoft, P&G, and Apple. Overall, China-savvy DJ-30 is underperforming the tech-savvy NQ-100 ON the Trump trade war tantrum.

Weekly-Technical trading levels: DJ-30, NQ-100, and Gold

Looking ahead, whatever the fundamental narrative, technically Dow Future (CMP: 44650) now has to sustain over 45300-45500 any further rally; otherwise sustaining below 45200, DJ-30 may again fall to 44500/44100-43700/43300 and 42800/41900 and further 41200/40600-40400/40000 in the coming days.

Similarly, NQ-100 Future (22300) has to sustain over 22400 for a further rally to 22500/22700-23000/23300 in the coming days; otherwise, sustaining below 22350-22100, NQ-100 may again fall to 21700/21300-21100/20700 and further 20500/20300-20100/19250 in the coming days.

Also, technically Gold (CMP: 2945) has to sustain over 2965-2975 for a further rally to 3000/3025-3050/3075; otherwise sustaining below 2955-2950 may again fall to 2925/2895-2875/2860 and 2840/2825-2800/2780 and 2750/2740-2725/2690 and further 2675/2655-2610/2560 in the coming days.