February 2025

Inflation last month continued to move lower.  The Consumer Price Index for February showed a 3.1% year-over-year rise, the smallest in nearly four years, and well off the 6.6% peak hit in the third quarter of 2022.  Even more encouraging, the month-over-month rate was 0.2%, which if sustainable would bring the annualized rate closer to the Fed’s stated target of 2.0%.  However, the February measure was a relatively clean comparison, as it took place before the global tariff battle was launched.  Much discussion has been had regarding the impact tariffs will have on prices, with the main contention being whether the impact on prices is inflationary or more of a one-time tax.  Those believing a tariff to be a tax cite tariffs as a tool of the Trump administration to “level the playing field” regarding trade and, in the case of Mexico, halt the flow of illegal immigration into the United States.  Arguably, with that dual mandate eminently achievable, the tariff induced price hike could be no more than a short-term price adjustment.  On the other side of the argument, inflation has been the source of contention for American’s for nearly three years.  The concept of perpetually rising prices is at risk of becoming imbedded in their thinking.  With that in mind, the tariff induced effect is likely to further ingrain that concept.

Meanwhile, the economy continues to show steady growth as evidenced by employment growth in February, which showed 151,000 new jobs created for the month, nearly matching the 160,000 expectations.  There was some concern that job growth would disappoint given that the ADP measure released earlier showed job growth of 77,000 for the month, about half of what was expected.  Also clouding the forecast is the supposed contraction of the government workforce as Elon Musk follows through on his cost savings endeavor.  Those jobs eliminated haven’t yet shown up in government measures, but we expect to see them soon.

Looking past the state of the economy, the capital markets over the last few weeks have been upended by the barrage of policy flip-flops coming out of Washington surrounding the implementation of President Trump’s trade tariffs.  The greatest impact has been on stock prices and the value of the U.S. dollar.  The S&P 500 reached an all-time high of 6,147.43 in February before coming under recent selling pressure.  Policy uncertainty has prompted the selling, causing the index to “correct” nearly 10% lower over the last three weeks, in a broad-based selloff.  Investors had been enthused at the start of the year by expectations that Trump was going to cut costs and reduce regulation resulting in a rise in profitability.  That, paired with a belief that the Federal Reserve would continue to lower interest rates contributed to the rally.  That sentiment has fully reversed with the Fed’s recent communication that rate cuts are likely to be slow in coming, which has stifled the buying and prompted aggressive selling.

Despite their public comments, Fed Fund futures indicate that the Fed will lower the overnight rate by 75 basis points by the end of this year.  Similarly, the two-year note rallied from a high of 4.35% in February to 4.00% at the time of this writing, with traders resisting the temptation to price in as aggressive rate cuts as the Fed Fund futures.  Amidst the confusion, the 2-year/30-year yield curve has steepened to 64 basis this month, as traders take a wait and see approach for policy moves.

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