Perception versus reality Perception versus reality http://www.georgiaprime.com/ga/static/images/ga/ga-logo-amp.png http://www.georgiaprime.com/ga/daf\images\insights\article\shopping-cart-store-small.jpg April 17 2025 April 17 2025

Perception versus reality

Should investors focus on solid hard data or weak soft data?
Published April 17 2025

Bottom Line 

The sharp ongoing juxtaposition between solid hard data and weak soft data continues. Recent reports on inflation, consumer spending, the labor market and corporate revenues and earnings have been fine. But that’s all decidedly rearview mirror stuff.

After President Trump’s bombshell tariff announcement, the S&P 500 plunged as far as 15% and benchmark 10-year Treasury yields soared from 4.0% to around 4.5%. Trump responded by pausing his tariff implementation for 90 days on all countries except China, which allowed financial markets to stabilize.

It’s been a dizzying two weeks, to be sure. Not surprisingly, recent confidence data and inflation expectations have been brutal, leaving investors in a state of confusion. While the hard data looks terrific, the concern is the impact of tariffs in the coming months and quarters. Given the economic uncertainty and market volatility due to Trump’s tariff policies, we expect inflation and unemployment to rise and the economy to slow. This is the definition of stagflation, but will it turn into a full-blown recession by year-end? Or are Trump’s threatened tariffs a negotiating tactic designed to result in lower foreign tariffs, stronger economic growth and higher equity prices? Our crystal ball is dark, though we suspect that the reality probably lies somewhere in between.

Inflation trending lower The strong progress on inflation the US experienced in 2023 as it continued to decline from the 40-year high in 2022 stalled last year. But over the past few months, inflation has begun to decrease again:

  • Core CPI retail inflation has declined steadily from a peak of 6.6% year-over-year (y/y) in September 2022 to 3.4% y/y in May 2024 before stalling at around 3.3% over the next eight months through January 2025. But it surprisingly plunged to lower-than-expected levels of 3.1% in February and a four-year low of 2.8% in March 2025. 
  • Core PPI wholesale inflation peaked at 9.7% y/y in March 2022 before plunging to 1.8% in December 2023. It then re-accelerated, more than doubling to 3.8% y/y in January 2025. However, wholesale inflation then surprisingly plunged to lower-than-expected levels of 3.5% in February and a six-month low of 3.3% in March 2025. 
  • Core PCE inflation (the Fed’s preferred measure) declined significantly from its peak of 5.6% y/y in February 2022 to 2.6% last June. But it stalled at 2.7-2.8% y/y over the next eight months through February 2025’s 2.8%. Given the strong improvement in March’s CPI and PPI readings, however, core PCE is now expected to decline to a four-year low of 2.5% in March 2025. The Federal Reserve is targeting 2% by year-end 2027. 
  • Average hourly earnings growth peaked at 8.1% y/y during the pandemic in April 2020 and has been grinding down by half to 4.0% in February 2025. But wage inflation surprisingly declined to 3.8 y/y growth in March 2025. The Fed is targeting 3.0%.
  • Crude oil (West Texas Intermediate, or WTI) plunged by more than 30% from nearly $81 per barrel in mid-January to $55 last week, though it bounced to around $64. Lagging gasoline prices have slipped 3% from $3.27 per gallon two weeks ago to $3.17, and could approach $2.50 during summer driving season.

Consumer spending has strengthened Nominal retail sales soared by a two-year high of 1.4% m/m in March 2025, up from a modest 0.2% month-over-month (m/m) gain in February 2025 and a brutal two-year low of -1.0% in January 2025. On a year-over-year (y/y) basis, March 2025 sales rose by a very strong 4.6%, up from a relatively solid 3.4% y/y in March 2024.

But investors are concerned that the sales strength stems from consumers intentionally buying now to beat potential price increases from tariffs later this year. Auto sales, for example, surged 11% m/m in March 2025, rising to a four-year high of 17.77 million annualized units from 16.0 million in February 2025. That suggests there could be a retail sales hangover coming later this year.

Labor market remains strong for now

Nonfarm payrolls rose by a stronger-than-expected 228,000 jobs in March 2025 versus 117,000 and 111,000 jobs in February and January, respectively. Initial weekly jobless claims for the April survey week were reported this morning at a stronger-than-expected two-month low of 215,000, which suggests that March’s payroll strength has legs. But the rate of unemployment  ticked up to 4.2% in March, a level the Fed expects to rise to its year-end target of 4.4%. Trump’s efforts to streamline federal government employment through layoffs are not yet filtering into the labor-market data, as workers who are receiving severance or are on paid leave are not listed as unemployed. 

Corporate reporting season gets off to a strong start We’re only 10% of the way into the first quarter of 2025 reporting season, but the early results are better than expected. Revenues are up 5.6% y/y, above a 4.2% consensus estimate, and earnings have risen 9.5% y/y, stronger than the consensus 7.3% increase. But company managements are providing cautious guidance for the balance of 2025, given the complete lack of visibility due to Trump’s uncertain tariff policy.

Confidence round trips Soft data like business and consumer confidence soared last year due to election-related enthusiasm. But the indices have given up all their gains this year, due to Trump’s tariff policy, while inflation expectations have skyrocketed: 

  • University of Michigan Consumer Sentiment Index soared from an eight-month low of 66.4 in July 2024 to an eight-month high of 74.0 in December 2024. But Michigan then plunged to a three-year low of 50.8 in April 2025, down from 57.0 in March. That’s the second lowest reading on record and the lowest since 50 in June 2022. Citing tariffs, respondents’ one-year inflation expectations surged from 5.0% in March 2025 to a 44-year high of 6.7% in April (7.3% in November 1981). Their 5-10 year inflation expectations rose from 4.1% in March 2025 to a 34-year high of 4.4% in April (4.5% in June 1991). It’s worth noting, however, that the sentiment data was skewed significantly by the political affiliation of the respondents. Democrats are generally despondent, while Republicans are more optimistic.
  • Conference Board’s Consumer Confidence Index rose from a nearly two-year low of 97.5 in April 2024 to a 16-month high of 112.8 in November 2024. But the index has since plunged to a four-year low of 92.9 in March 2025. In addition, its expectations index plummeted from a three-year high of 93.7 in November 2024 to a 12-year low of 65.2 in March 2025. 
  • NFIB Small Business Optimism Index rose from an 11-year low of 88.5 in March 2024 to a six-year high of 105.1 in December 2024. But the index fell to 97.4 in March 2025.

What should the Fed do? Chair Jerome Powell and the Fed have a tough row to hoe here. With inflation declining and unemployment rising, the consensus view on Wall Street is that the Fed should reduce the fed funds rate from an upper band of 4.5% now by three or four quarter-point cuts over the remaining six FOMC meetings this year. But in a speech yesterday at the Economic Club of Chicago, Powell said that Trump’s tariffs are causing inflation and unemployment to rise and growth to slow. Given that tradeoff between the Fed’s mandated goals of maintaining low inflation and full employment, Powell suggested that there was no Fed put, and that policymakers would remain patiently on the sidelines, evaluating the hard data in coming months. We at Federated Hermes believe that the Fed may cut two or three times this year, with the first coming in June.

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DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

The Conference Board's Consumer Confidence Index measures how optimistic or pessimistic consumers are about the economy.

Consumer Price Index (CPI): A measure of inflation at the retail level.

The National Federation of Independent Business (NFIB) conducts surveys monthly to gauge how small businesses feel about the economy, their situation and their plans.

Personal Consumption Expenditures Price Index (PCE): A measure of inflation at the consumer level.

Producer Price Index (PPI): A measure of inflation at the wholesale level.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

The University of Michigan Consumer Sentiment Index is a measure of consumer confidence based on a monthly telephone survey by the University of Michigan that gathers information on consumer expectations regarding the overall economy.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Stocks are subject to risks and fluctuate in value.

The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results. 

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