The main news over the past few sessions has been Trump going tariff heavy. What he is doing with Canada, Mexico and China is very self-destructive, if by self we refer to the United States, rather than to Trump personally. And I assume that the equity market would be lower if people did not hold out a decent degree of hope of him climbing down on this. I do not have a view on that political consideration, but the economics involved here suggest that this is unlikely to be a speed bump.
The Trump program, as stated and now largely “enacted,” involves a couple percentage points added to the inflation rate for about a year, as a first approximation, and a good chance that the US falls into recession, either because the Fed reacts to the inflation or – equally plausibly – because tariffs are a supply side shock with direct growth implications. Please see the second half of my note on the Atlanta Fed bean count yesterday for my guesstimate read through of what the Fed’s own work implies about that.
The equity market’s reaction so far does not really show up as anything
Source: Robert Shiller, Bloomberg, BEA, FH calculations
S&P500 pricing is to 10:30 this morning.
In pointing this out, I am being a reporter, not an analyst. This result comes from conventional analysis, the details of which are beyond my competence, taking as inputs what is apparently actually happening. The absence of major real imbalances in the US economy suggests that it is resilient to a shock, but this shock looks large enough to dominate that advantage, based on work done by my betters.
In this note, I want to follow up on a point that is currently distantly secondary, but where I would claim to have a bit of technical competence. I refer to the Atlanta Fed’s bean count for the first quarter GDP growth rate, which implies that the US economy is already in recession. I choose my words carefully here to respect that the tariffs themselves might take a couple months to put the US economy into a recession but that if Q1 is already tracking deeply negative, then that does make for a recession. A recession happens when the NBER Business Cycle Dating Committee says there has been one, not when there is a particular pattern of recorded GDP growth, but the two are related.
I am quite confident that the Atlanta Fed’s bean count is simply mistaken and in a way that can be known in real time. And before getting into the actual argument, it might be useful context here to comment on a quirk that I have long noticed among Wall Street economic analysts, perhaps especially on the sell side. We all have our biases and blind spots. Mine is that I rely too much on a priori reasoning. But it is striking how the discussion around this issue is so dominated by technical minutia.
For example, more than half the deterioration of the trade balance between December and January can be attributed to intermediate inputs, in which non-monetary gold is accounted. I hasten to add that non-monetary gold need not be the dominant driver here, simply because it is part of the component that moved most. But apparently, the BEA treats non-monetary gold differently from Census when the former works up its estimates for current quarter GDP.
Seriously, that is the argument? Perhaps we could stop trying to wow our friends with our understanding of technical minutia. Of course, this is something I would say because I do not have a solid grasp of that technical minutia. The Atlanta Fed pencils in 3.6 percentage points of trade drag, due entirely to a surge of imports, at a time when domestic demand growth is rising at an annualized rate of 0.8%. So, what they have “in mind” (the model is explicitly mindless) here is most certainly not a grab for imports by consumers or businesses ahead of tariffs. No, businesses and consumers are retrenching their spending (growth), but within that there is a totally unprecedented and bizarre shift of that weakening demand towards imports.
Leaving aside disagreements among statisticians at Census and BEA, most of whom have probably been fired by the DOGE teenagers anyway, about how to treat non-monetary gold, is that remotely plausible? No, it is not. So, it would not be a good idea to assume that it is actually happening.
So, what is happening? I would say there are three things:
- Demand growth is apparently slowing, restrained by highly elevated uncertainty and moderate, chronic trade drag associated with the high dollar.
- The tariffs are threatening to turn this into a recession and there is a good chance they will do so if not reversed.
- What the Atlanta Fed is seeing on the import side is either a mismeasurement, perhaps partly involving non-monetary gold, and/or is being offset by a surge of demand, most plausibly for inventories, that the Atlanta Fed model is not yet picking up and which cannot be add factored with discretion on the part of the Atlanta Fed analysts because they specifically swear off doing that.
A sensible guess for Q1 GDP growth might be in the neighborhood of 1%, if the tariffs were to be reversed almost immediately. And the likelihood that the US is not already in recession would become quite relevant to investors if that tariff reversal were to be achieved. For now, yes, the tariffs are dominant.
