Markets Surge on Tariff Truce as Signs of Tariffs Show Up in Data

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

The markets continued to rally as many investors believe the thick of tariff uncertainty is behind us. This view was boosted last week following news that the U.S. and China announced a 90-day pause in tariffs. The pause followed the U.S. and United Kingdom (UK) agreeing on a framework of a trade agreement earlier this month. While recent progress on trade policy with China and the UK may be a sign that uncertainty about the direction of tariffs is easing, we believe we have yet to see the peak impact that the new levies will have on the economy. As we’ve detailed over the past several weeks, surveys of consumers and businesses—or so-called soft data—have signaled the tariffs could lead to slower growth and potentially higher prices. This view is shared by Federal Reserve Chair Jerome Powell as reflected in his public comments of late. However, so far, investors have had to take a wait-and-see approach to determine whether the soft data will show up in hard economic numbers. In other words, the big question on investors’ minds is this: Will tariffs lead to higher inflation and slower economic growth, or is economic theory different from reality?

The answer is complicated by two key factors. First, we don’t know what the final tariffs are going to be, although we suspect they’ll end up in the low to mid-teens when factoring in the 10 percent universal tariff and additional sector tariffs. While this estimate is much lower than the reciprocal rates announced in early April, it would still be the highest tariffs we’ve seen in 80 years. And second, the “hard” economic data has been unusual thanks to demand being pulled forward by both companies and consumers in anticipation of tariffs taking effect.

While it is likely to be months before the full impact of tariffs will be known, we received some hard evidence the administration’s approach to trade is having an impact. Data out last week showed that revenue in the form of customs collections for April ticked up, coming in at $16 billion from around $6.3 billion a year ago, which was essentially the run rate from 2019 when Trump’s original China tariffs went into effect. Prior to that, from about 2015 to 2019, the run rate was around $2.5 to $3.5 billion. This means tariffs are indeed being collected—and the question at hand is this: Who is paying for them? The answer is likely some combination of foreign entities and American businesses and consumers. In the coming months, we believe the costs stemming from tariffs will show up in the economy. Indeed, Walmart Chief Financial Officer John David Rainey said last week during an interview following the company’s earnings release, “The price increases related to tariffs—we really haven’t seen [them] yet,” adding, “These are happening right now, and they’ll become more obvious.”

Rainey followed up on the statement by noting that the magnitude of the tariff increases are just so large that retailers can’t absorb them alone, and consumers are going to feel some of the increases. In a nod to the uncertainty that companies are facing, Walmart also decided not to provide future earnings guidance, as 1) they are unable to confidently predict changes in trade outcomes, and 2) they are bracing for a bigger hit from the trade war and overall economic malaise in the coming months.

While the debate on whether tariffs will produce a one-time step-up in costs or lead to sustained inflationary pressures continues, the new direction is likely to result in long-term changes to the global economic landscape. For example, Apple has announced its plans to move its manufacturing to India from China because of the high tariffs imposed on goods from China. This news was panned by President Trump, who spoke with Apple CEO Tim Cook about the plan. Trump said that he told Cook, “I don’t want you to build in India” and that he wants Apple products for the U.S. market built in the U.S.

We note the above exchange between the president and Cook to highlight that the new approach to trade has implications. Certainly it takes time to build supply chains, and it is going to be more expensive to build phones in the U.S., which likely means some combination of price hikes for U.S. consumers or lower margins for U.S. companies in the future, with an open question of whether it will spur stronger, long-term U.S. economic growth, which is the administration’s goal.

While tariffs continue to provide uncertainty, another key component of the administration’s agenda is working its way through Washington. The Republican tax bill passed a key hurdle on Sunday as it was voted out of committee, clearing the way for a vote by Congress potentially this week. The bill had been stuck in committee for days by a handful of Republicans who were concerned that proposed spending cuts in the bill were not enough. This issue was further brought to the fore with news that Moody’s was downgrading the U.S. from AAA to Aa1 given the large U.S. deficit and the cost of servicing the national debt. Importantly, the U.S. is no longer rated AAA by any of the three major ratings agencies. While we don’t believe the change in rating will have a significant near- to intermediate-term effect on the Treasurys market, it does highlight how the fiscal situation of the U.S. is another challenge for an economy undergoing a significant transformation.

Considering these challenges, we continue to believe in diversification and are ready for markets to broaden out from a narrow group of leaders. While valuations are an imperfect timing tool, we believe they continue to be a strong indicator of where intermediate- to long-term potential lies. That said, the macroeconomic winds have shifted, and we believe they will favor different asset classes moving forward. For more information on this topic, check out our recent Quarterly Market Commentary and Asset Allocation Focus.

Wall Street wrap

Inflation continues to slow: The latest Consumer Price Index (CPI) from the Bureau of Labor Statistics (BLS) showed that prices rose 0.2 percent in April, up after a 0.1 percent decline in March. On a year-over-year basis, the headline figure was up 2.3 percent, marking the lowest level since February 2021. Core inflation, which excludes volatile food and energy costs and is the measure that the Federal Reserve focuses on, rose 0.2 percent in April, up from 0.1 percent recorded in March. Over the past 12 months, core CPI is now up 2.8 percent on a year-over-year basis.

Goods prices rose 0.1 percent for the month and have now been positive or flat for six of the past seven months. Still, on a year-over-year basis, goods prices are essentially flat. Services prices rose 0.3 percent in April, up from a 0.1 percent increase last month. They are now up 3.6 percent on a year-over-year basis, down from March’s year-over-year pace of 3.7 percent.

Because services readings include the lagging housing category, we typically look at services inflation excluding shelter to get a clearer picture of current measures of price pressures. Services prices excluding shelter were up 0.3 percent for the month. So-called “super core” prices rose 0.21 percent. On a year-over-year basis, super core prices are up 2.74 percent.

Inflation measures by some of the regional Federal Reserve banks, designed to gauge overall trends of inflation, show inflation remains sticky. The Cleveland Federal Reserve’s calculation, called the Cleveland Median CPI, came in at 0.33 percent in April, little changed from March’s 0.34 reading. On a three- and six-month annualized basis, the measure is up 3.82 percent and 3.62 percent, respectively. The year-over-year reading comes in at 3.5 percent. While the latest inflation readings are generally encouraging, we don’t believe this month is reflective of the full impact of tariffs and needs to be taken in the context of the prior few months due to the reality that companies and consumers likely bought ahead of expected tariffs.

Small business optimism weakens: The latest data from the National Federation of Independent Businesses shows that optimism among small businesses fell 1.6 points in April, to a level of 95.8. The latest reading marks the second consecutive month that optimism was below the 51-year average of 98. Meanwhile, the Uncertainty Index declined to 92, falling four points but still elevated compared to historical norms.

A closer look at the report shows that expectations about the future continue to dim. The net percentage of respondents who expect the economy to improve fell six points in April to 15, down from 47 percent at the beginning of the year and less than a third of the post-presidential election high of 52 percent.

Sales for small businesses have been in decline since June 2022, including the latest reading showing a still historically depressed 8 percent more businesses (three points better than in March) reporting declining sales than reporting flat or rising purchases. Against these still weak sales levels, selling prices pulled back, albeit still at historically elevated levels, with 25 percent of respondents noting higher selling prices compared to 26 percent in March. Costs for businesses continued to rise, with 33 percent of respondents reporting they raised compensation in the prior three months. This figure is down from 38 percent in March but still elevated.

Wage growth and slow sales have translated to generally slow earnings for small businesses since COVID. The latest reading shows a net 21 percent of business owners have seen their earnings shrink over the past three months, seven points better than March’s reading but still suggesting weak profitability by historical standards. Among owners reporting lower profits, 38 percent blamed weaker sales, 14 percent cited usual seasonal change, 11 percent cited the rise in the cost of materials, and 8 percent cited labor costs. All of this led to tepid hiring by companies.

The portion of businesses expecting to hire in the next three months declined in March. The latest results show 13 percent of companies expect to add to payrolls, an increase of one point from March. Those who are hiring continue to struggle finding qualified help, with 47 percent of those hiring reporting a lack of qualified candidates, unchanged from the prior month. As we’ve noted in the past, a scarcity of qualified workers can lead to a rise in wages. But while finding qualified candidates continues to pose challenges, companies are less willing to bid up for talent. The latest results show that 33 percent of businesses reported raising compensation in the past three months, a decrease of five points from the prior month. The latest survey results show the portion of businesses expecting to raise wages in the next three months fell two points to 17 percent.

Retail sales growth slows as tariffs begin to curb demand: The latest retail sales numbers from the U.S. Census Bureau show that growth in consumer spending slowed last month, with overall retail and food service sales rising just 0.1 percent in April. The rise was slightly above Wall Street’s expectations for sales to be flat and significantly lower than the 1.7 percent increase seen in March.

Overall, seven of the 13 categories declined in April’s report, led by a 2.5 percent drop in sales at sporting goods and hobby stores; sales at department stores fell 1.4 percent, and specialized retailers experienced a drop of 2.1 percent. Overall retail sales are up 5.1 percent year over year on a seasonally adjusted basis. The slowdown in sales growth occurred as President Trump’s tariffs began to weigh on consumers, who bought ahead of expected price increases in March. Overall, the Control Group (which is a proxy for the spending measure found in gross domestic product growth) fell 0.2 percent for the month, falling short of Wall Street expectations of a 0.3 percent increase, and was down from March’s growth of 0.5 percent.

Homebuilders’ uncertainty continues to grow: Homebuilder confidence dropped sharply in May to the lowest level in 18 months as builders’ concerns about tariffs, interest rates and higher construction costs continued to mount. The latest reading from the National Association of Home Builders (NAHB) survey shows confidence came in at 34 in May, down six points from April. However, it is noteworthy that 90 percent of survey responses were received prior to the May 12 announcement that the U.S. and China would cut tariffs for 90 days as trade talks continue. NAHB Chairman Buddy Hughes, a home builder and developer from Lexington, N.C., weighed in, saying, “Builders expect future trade negotiations and progress on tax policy will help stabilize the economic outlook and strengthen housing demand.”

Consumer sentiment falls as inflation expectations rise: Consumer sentiment dropped for the fifth month in a row, falling 1.4 points to 50.8, according to the latest consumer sentiment survey released by the University of Michigan. That’s down 30 percent since January and just shy of the index’s all-time low of 50 seen in June of 2022. Views of current economic conditions fell 2.2 points, and expectations for the future also softened. Clearly, tariffs continue to weigh heavily on the minds of consumers, as nearly three-quarters of respondents spontaneously mentioned them in this month’s report, up from almost 60 percent who did the same in April.

Concerns about the economy are showing signs of affecting consumers’ thinking on future purchases. The latest survey shows just 17 percent of respondents expect to continue to spend as usual on items that experience significant price increases. By contrast, from August through October 2022, during the COVID-induced spike in inflation, approximately 36 percent of respondents expected to continue to spend on items despite sharp price increases. This suggests that consumer spending may not be as resilient should tariffs lead to higher prices as consumers have become more price sensitive in light of cooling prospects in the labor market and dampened expectations about their income outlook going forward.

Minor increases in sentiment among independents were offset by a 7 percent decline among Republicans. It’s noteworthy that interviews for the May report were largely completed before the pause announced by the U.S. and China on most tariffs between the two countries. While some measures did indicate improvements following the announcement, they were too small to change the broader picture.

Year-ahead inflation expectations surged to 7.3 percent from last month’s final reading of 6.5 percent. More importantly, inflation expectations five to 10 years ahead rose to 4.6 percent from 4.4 percent, up from the year-end 2024 level of 3 percent and the highest reading since early 1991. Rising inflation expectations are likely to keep the Fed sidelined over the coming months given their fear that higher inflation stemming from tariffs could become embedded in consumer and corporate expectations and lead to more persistent inflation similar to the 1966–1982 time frame.

Even though final survey results may change somewhat as more interviews following Trump’s temporary pause on some tariffs of Chinese goods are added into the mix, the trend of sharp increases in inflation expectations along with growing concerns about the economy and personal finances could translate to a further slowdown in consumer spending, putting additional pressure on economic growth.

Jobless claims unchanged from last week: Initial jobless claims were 229,000, unchanged from the prior week’s final figure and in line with forecasts. The four-week rolling average of new jobless claims came in at 230,500, up 3,250 from the previous week’s average.

Continuing claims (those people remaining on unemployment benefits) stand at 1.881 million, up 9,000 from the previous week’s revised total. As we’ve noted in prior commentaries, we believe continuing claims are a more reliable indicator of the labor market, as they measure workers who are facing long-term challenges in finding a job and, as such, filter out some of the temporary noise that can be found in initial claims data.

The week ahead

Monday: The Conference Board’s latest Leading Economic Index Survey for April will be out mid-morning. Last month’s report showed some weakening in the near term, and the longer-term view suggests some headwinds for the economy. We will be scrutinizing the data to see if last month’s decline was a temporary setback.

Thursday: We’ll get an update on the health of manufacturing and services in the U.S. when S&P Global releases its Flash Purchasing Manufacturers Index reports for May. Services showed a slowdown last month, while manufacturing moved back into expansionary territory. We will be watching to see if ongoing uncertainty about tariffs has had an impact on recent trends for both sectors.

We’ll get insights into the housing market when the National Association of Realtors releases existing home sales for April. This report should give a clearer picture of whether the housing market is still stuck in a holding pattern due to elevated interest rates and home prices.

Friday: The U.S. Census Bureau will release data on new home sales for April. This report along with the existing home sales data will provide a look at the health of the real estate sector.

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