Growing Tariff Anxiety Overshadows Payrolls Data
The labor market remains robust but tariffs threats are unnerving US consumers.
Weekly Highlights
Lots of crosscurrents, but trend still looks OK.
No warning sign for Fed here as labor market doing fine.
As broadly expected.
Warning sign for Fed as tariff anxiety takes hold.
Healthy job gains. Lower interest rate clearly took effect.
Contraction continues.
Picking up from an upwardly revised 3.9%.
Way above the consensus of -0.5%.
Better than consensus, positive for Q4 growth.
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US: Consumers Do Not Like Tariffs!
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.
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Catch the whole story...
There's more to the Weekly Economic Perspectives in PDF. Take a look at our Week in Review table – a short and sweet summary of the major data releases and the key developments to look out for next week.
UK: BoE Is Moving Carefully
The BoE decided to lower policy rate by 25 bps to 4.50% as widely expected. The bank also showed further signs that the easing cycle might turn out to be deeper than market expected.
The dovish vote split 7-2, with two dissenting voters favoring a 50bp reduction was a surprise to market but that was offset by the bank’s hawkish projections. And against greater economic uncertainty and unclear state of underlying inflation, the central bank also judged that “a gradual and careful approach to the further withdrawal of monetary policy restraint is appropriate”.
The bank has halved its 2025 GDP growth forecast from 1.5% to 0.75% but revised up CPI inflation. The BoE now expects CPI inflation will rise from 2.5% in December to a peak of 3.7% in Q3 2025, compared to 2.8% previously. It also projects that in three years’ time inflation will be 1.9% compared to 1.8% previously. The Committee also expects the margin of excess supply to “widen further over the next couple of years, to around 0.75% of potential GDP”.
Overall, this is in line with our view that downside growth risks will outdo inflation worries. For a context, the economic activity has lost momentum since the second half of 2024. Households remain cautious while business investments continue to be affected by tax hike and the increase in employer NICs. Final manufacturing pointed to a soft decline in activity while services PMI showed marginal expansion.
The labor market is undoubtedly weaking in a dovish risk for the bank. Private sector employment declined throughout last year, and vacancy rates are now well below pre-covid levels in most sectors. Our view is that services inflation, which is the BoE’s key indicator, is likely to fall back in Q2 and probably further than the Bank’s latest projections suggest. We continue to see the policy rate at 3.5% by year end.
Japan: Steady Strength
Overall wages rose strongly along with steady base wage growth in December. Overall cash earnings grew 4.8% y/y, well above the consensus of 3.4% and the highest since 1997. This surge is the work of a record 6.8% jump in winter bonuses. On a constant sample basis, the growth was even better at 5.2%. As the effects of these special payments drop out, we will see the data revert lower, but nonetheless the trend of higher wage growth is clear now.
This year’s shunto wage negotiations began last week, and the stage is set for another strong showing. High inflation expectations and the general limitations on labor availability may result in another year of record high wage growth, likely an upside surprise to expectations as we outlined recently. Furthermore, we expect the wages to broaden into other industries and also see the attitudes toward wage growth changing. For example, the mining industry saw their wages rise a whopping 30%, while that in real estate remains subdued at 1.3%. These wide differences may reduce after this year’s shunto negotiations.
Furthermore, household spending in December surprised to the upside by rising 2.3% m/m, as opposed to a consensus for a small decline of -0.5%. This translated into the fastest annual growth rate of 2.7% y/y since August 2022. Despite that, the Bank of Japan’s (BoJ) Consumption Activity Index eased 0.5% m/m on weak non-durable good consumption. Nonetheless, we expect household consumption to have remained buoyant at least nominally in Q4. As the CAI is measured on a price adjusted basis, we suspect if consumption was pulled lower by higher inflation.
All of these data warrant more hawkishness from the Bank of Japan (BoJ), as we expect another 25 bps of hike this year. The Bank’s most hawkish member Naoki Tamura upped the ante and said that the BoJ ‘must raise rates at least to around 1% this fiscal’. He stressed that inflation may be affecting consumption, as noted above.
While acknowledging these upside risks to our 0.75% terminal rate forecast, we maintain it for now and look for Q4 GDP (data to be released on Feb 17) to have risen near the potential growth rate of 1.0% y/y. Any downside risks may turn the hawkishness, but if growth comes above expectations, the upside risks to the policy rate may become realistic and bring the next hike sooner rather than later.