And that question is really at the crux at the moment. Chaotic noise?? It’s getting harder to make out the shape of the economy through the fog of Trump 2.0’s fiscal detox and tariffs. Indeed, one regional Fed bank sees US real GDP contracting this quarter, another sees it expanding, and bad weather has distorted signals from several economic indicators. No wonder the stock market’s default position is risk-off and stocks have been correcting across the board with US small companies as proxied by Russel 2000, particularly hit hard.
Economists have progressively been losing confidence that the US economy will avoid a recession, with many raising the odds of a recession to the 40% level – and have gone +15% in the space of one week!!!. And if there isn’t enough uncertainty, it is conceivable that the Trump Fiscal and Tariff Turmoil 2.0 could trigger a rare kind of flash crash unaccompanied by a recession.
The noise-to-signal ratio of economic data print has been rising rapidly in recent weeks. As a result, it has gotten harder to get a clear read on the economy lately. This is consistent with policy uncertainty index (that we referenced last week) which has spiked of late. With Trump officials recently acknowledging that they expect their policies to cause some short-term pain, the near-term outlook for the economy and stock market has soured rapidly over the past few weeks.
The DOGE team have been firing government workers faster than anyone expected. That might slow now, that various Cabinet secretaries reportingly are pushing back against Elon Musk’s terminators. The Trump administration’s tariff policies are instigating a retaliatory trade war rather than the negotiations to reduce tariffs that we had expected. More “reciprocal” tariffs will be imposed on April 2 by the Trump administration, which also aims to raise revenues with tariffs, implying that some of the tariffs will be permanent. The tariff announcements have not peaked yet with additional announcements planned over April, May and June.
Stock investors are confused and seem to have concluded that the economy may be falling quickly into a recession and this will have significant impact on both earnings per share (which could drop from lower double digit growth in 2025 into single digit level) as well the multiple investors are prepared to pay for a dollar of earnings out of US companies. No wonder risk-off is the stock market’s current default option. Both the Nasdaq and S&P 500 is in correction territory as investors reduce their exposure to US equities. The smaller companies proxy index Russell 200o has take a large hit, reflecting that margins and operating earnings of smaller companies may be impacted more severely from the slower economy.
The latest batch of economic indicators are heightening recession fears?
Consider the following:
(1) Atlanta Fed versus New York Fed Nowcasts. The Atlanta Fed’s GDPNow tracking model is currently showing Q1’s real GDP decreasing by 2.4% (q/q saar). However, the New York Fed’s Nowcast tracking model shows it increasing 2.7%! Confusing?
Most economists typically favour the Atlanta Fed model over the New York Fed one. However, it is unclear why the two models differ so much currently. What we do know is that the Atlanta Fed’s GDPNow estimate dropped from +2.3% to -1.5% following the release on February 28 of a big jump in January’s imports, led by an odd jump
in gold imports. In addition, on that same day, January’s real personal consumption expenditures showed a big decline of -0.5% m/m. The GDPNow estimate was lowered again to -2.8% on March 3 after the release of the ISM manufacturing index for February. It is currently -2.4%.
But what we think is the real point on the dramatic changes and variance – chaotic economic trends driven by policy uncertainty. And that is the problem in itself.
(2) Retails sales are facing headwinds. The drop in real consumer spending during January undoubtedly was caused by inclement weather in that month, which was the coldest since 1988. Industrial output of utilities soared to a record high in January. Auto sales fell sharply in January and rebounded slightly in February. Retail sales excluding food services dropped 1.2% MoM during January. And, the Consumer Confidence Index survey showed a sharp decline in vacation plans during February. Furthermore, Target said on Tuesday that it expects little to no sales growth this year, with CEO Brian Cornell telling CNBC that higher prices are on the way. Walmart and electronics retailer Best Buy also recently warned about expectations for 2025. Similar sentiments were expressed by CEOs of major airlines.
(3) Cyclical recovery in PMIs dented. February’s purchasing managers index (PMI) added to the dissonance provided by the latest batch of economic indicators. The Manufacturing PMI dipped to 50.3 in February from 50.9 in January, denting any hope for cyclical recovery.
(4) Employment market is softening. February’s payroll employment gain was weaker than expected by the market. Maybe the first cracks in the employment market is starting to show even before full DOGE detox related data starts to flow through. The questions ahead are – how much will federal government employment fall in coming months as a result of the DOGE fiscal tightening, and will private payroll gains more than offset the losses from Federal government? The losses started in February with federal government employment down 10,000. February’s Challenger Report showed that government-announced layoffs totalled 62,240. In the private sector, announced layoffs in retailing during February totalled 38,960, the second highest tally on record.
(5) Wall Street’s expectations is souring. Wall Street’s confidence in Corporate America’s profit engine is fraying, threatening more turbulence ahead for a badly bruised US stock market. Though the broad outlook for corporate earnings remains strong (13% for 2025), analysts have been steadily trimming their expectations to allow for greater uncertainty, lower confidence and the direct impact from fiscal tightening and tariff related contraction. Profit forecasts for S&P 500 Index companies have seen more downgrades than upgrades for 22 of the past 23 weeks, according to Bloomberg Intelligence, the longest stretch since early 2023. Whether we have US recession or not, the impact on earnings per share from Trump policies is likely to be material. This uncertainty also increases equity risk premium which implies the forward multiple need to be adjusted down.
Exhibit 1: Negative Surprises & Earnings Revisions |
(6) High Yield Spreads Tightening. High Yield spreads have widened by the most in six months this past week, notwithstanding that they remain near historic lows. The flipside – meaning they could move out significantly more if a recession hits. Goldman Sachs Group Inc. strategists have already sharply raised their forecasts for the risk premiums as tariff risks increase and the White House flags that it is willing to tolerate short-term pain to address the trade and fiscal deficit. Trumps key philosophy is driven by MAGA. They now expect high-yield spreads to reach 440 basis points in the third quarter compared with 295 basis points previously expected. On March 13th, the HY spread was 335 basis points.
Exhibit 2: High Yield Spreads have Tightened the Most in 6 Months |
(7) Private Credit is Not Immune. The whipsawing of US economic policy is making it harder for private capital firms (private equity) to sell off their holdings and many have added more expensive debt to their portfolio companies in response, much of it from private credit lenders. At a conference in London last week, a number of attendees spoke on the sidelines of concerns about interest-coverage ratios at private equity-owned companies, the risk that their firms are holding too much leverage and the need for direct lenders to diversify away from a possible overexposure to corporate credit. Any tightening of belt by non-bank sector is likely to contribute towards already tightening financial conditions.