Tariffs Spark Concerns About Economic Growth

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

As the old investing adage goes, “Markets hate uncertainty.” And judging by the performance of stocks last week, investors are feeling unsure. The three major indices all finished sharply lower for the week with the S&P 500 posting its worst week since September 2024. While uncertainty is a natural part of investing, it has taken on added weight since the beginning of the year. Investors who had been focused primarily on questions about inflation, the underlying strength of the job market and when and by how much the Fed would cut rates have had to consider each of those questions with the added uncertainty of different policies—including tariffs—from the new administration. Adding to the challenge is the fluid nature of tariff announcements with new levies being proposed, implemented or paused in short order. At the same time, recent economic data has shown sticky inflation and signs of a cooling job market. The combination of strains consistent with a late-stage economy and the new wild card of tariffs have led to concerns about slowing economic growth.  

Last week’s jobs data showed signs that the job market was cooling further and raised more questions about the underlying strength of the economy. Job numbers came in below Wall Street expectations. The Atlanta Federal Reserve’s GDP Now indicator, which we detailed in last week’s commentary, weakened further, with the latest estimate showing GDP tracking at a decline of 2.4 percent this quarter.

While the administration has yet to solidify final details of its tariff policies, we believe they are part of a broader move to change the way the government operates and change the way the U.S. engages in trade and defense around the world. Indeed, Peter Navarro, the senior counselor for trade and manufacturing to the president, described the administration’s efforts as a “restructuring of the global trade environment.” While it is premature to speculate how the planned restructuring will ultimately play out, we believe that it is almost certain to bring heightened volatility and further uncertainty. As new policies are unveiled, each will bring the possibility of intended as well as unanticipated results.

In fact, we have already seen an early unexpected beneficiary of some of the president’s plans. European stocks have had a strong start to the year, rising more than 17 percent as measured by the MSCI European Economic and Monetary Union Index. Previously, stocks of large European companies had languished as slow growth weighed on prospects for many of the region’s companies. However, investors have taken a renewed interest in European equites in anticipation of countries in the region having to spend more money on defense as a result of the current administration’s view of the U.S. role in defense abroad. To that end, the new German government proposed the creation of a 500 billion euro infrastructure and defense fund.

We highlight the above dynamic not as a judgment on policy or to suggest that the recent surge for the asset class marks an inflection point for performance leadership. Instead, we believe it effectively demonstrates that change can have unpredictable effects on the economy and markets. During any period of significant upheaval, risks rise—but so, too, do unpredictable opportunities. As such, we believe the best way to approach uncertainty is through diversification. By owning different asset classes, investors will have exposure to investments that may perform well even as others lag, regardless of the geopolitical or economic backdrop.

Wall Street wrap

Hiring falls short of expectations: Last week’s Nonfarm payroll report from the Bureau of Labor Statitistics (BLS) showed weaker than expected growth with 151,000 new jobs added in February, including 140,000 positions in private industry. The diffusion index (which measures the portion of the 250 industries covered by the report that added jobs versus those in which employment is unchanged or declining) increased to 58.4 percent versus January’s level of 52.4 percent. The three-month diffusion index decreased slightly to 62 percent but remains well above the weak levels seen last summer.

Hourly pay for non-supervisory production employees grew by 0.3 percent for the month and was up 4.1 percent year over year. The pace of wage growth is still above the 3 to 3.5 percent rate the Fed believes is consistent with its goal of inflation sustainably at 2 percent. The latest data shows that the average work week held steady at a low 34.1 hours, which, along with January’s total, is the fewest number of hours recorded since March 2020 and, before that, in 2010, when the economy was coming out of the Great Financial Crisis. The shorter work week may signal that companies are trying to contain payroll costs in the near term while they try to determine how economic policies will affect their needs for workers going forward.

The BLS’s other jobs report, the Household survey, showed the unemployment rate rose to 4.1 percent from 4 percent in January. The labor force participation rate edged lower to 62.4 percent from the prior month’s 62.6 percent. The participation rate is now at the lowest level in two years. In total, the Household report showed 588,000 fewer people employed in February than during the prior month. Of that number, 385,000 dropped out of the workforce, and 203,00 joined the ranks of the unemployed.

More on the employment picture: Announced job cuts in February totaled 172,017, up 103 percent from the same month a year ago, according to the latest report from Challenger, Gray & Christmas Outplacement Services. This marks the highest number of announced cuts since July 2020. In total, more than 221,800 job cuts have been announced since the beginning of the year, which is the highest two-month total to start a year since 2009, during the Great Financial Crisis. Perhaps not surprisingly, more than a third of the cuts (62,242) came from government payrolls as the Department of Government Efficiency has sought to aggressively reduce the federal workforce.

While announced cuts to government payrolls surged, there were signs of hiring in the private sector with 34,580 new hires announced by companies. This brings the total hiring announcements during the first two months of the year to 40,669, which is a 159 percent increase from the same period last year.

Pace of growth slows for manufacturers: The latest data from the Insitute of Supply Management (ISM) shows the manufacturing sector expanded for the second consecutive month after a streak of 26 months of contraction. The composite reading for the index for February came in at 50.3, down 0.6 points from the previous month (readings above 50 signal expansion). Strength was solid, with four of the six major industries reporting growth, unchanged from February. However, details from the report suggest that the recent expansion is still fragile. Readings for new orders dropped to 48.6, down 6.5 points from January. This breaks a string of three months of improved readings for demand. The production index declined by 1.8 points to 50.7, and the employment index dipped back into contraction territory at 47.6, down 2.7 points from January. Weaker growth was largely attributed to policy decisions from Washington. “Demand eased, production stabilized, and destaffing continued as panelists’ companies experienced the first operational shock of the new administration’s tariff policy,” Tim Fiore, chair of the ISM, noted in comments released with the report.

Tariffs also played a role in the acceleration of price pressures for manufacturers. Prices jumped, with the latest reading coming in at 62.4, up 7.5 points from January. This marks the fifth consecutive month that manufacturers have faced higher costs for raw materials. It is the sharpest uptick in prices since January 2024 and the highest level since June 2022. The recent trend in rising costs comes at a time when the Fed is seeing heightened risks on both sides of its dual mandate of price stability and full employment and adds to the case for the Fed to hold rates at current levels.

Services sector improves: ISM data for the services side of the economy showed an uptick in the pace of expansion, with February’s headline reading coming in at 53.5, up from January’s final reading of 52.8. The acceleration of growth came as strength held steady, with 14 of 18 industries reporting growth, unchanged from January. New orders edged higher to 52.2, up from January’s reading of 51.3. Importantly, much as for the manufacturing index, prices moved higher, with the latest reading coming in at 62.6, up from 60.4 in January. Increased price pressures were widespread, with 16 of 18 industries reporting higher costs. The latest reading marks the third consecutive month that the prices index was at 60 or above, a condition not seen since the first three months of 2023.

The latest results from the survey showed the employment index rose to 53.9, up 1.6 points from January’s final reading. Seven of 18 industries reported growth in employment, while seven recorded declines in payrolls; the remaining seven saw little or no change in hiring. Among comments from survey respondents were the statements “Pre-planned increase in staff to accommodate higher revenue/fundraising” and “Delays in hiring as a result of U.S. government actions/executive orders; employees on furlough.” While these comments are anecdotal observations, they provide another example of how plans made based on optimism at the beginning of the year are running into the challenges that come from a late-stage economy that is adapting to potential trade policy shifts.

Beige Book points to flat growth and rising prices: The latest release of the Federal Reserve’s Beige Book, which provides real-time anecdotal assessments of business conditions across the country, showed the pace of the economy improved slightly from the beginning of the year, with four of 12 districts reporting growth ranging from modest to moderate, two districts signaling a decline in activity and six districts seeing little or no change. Similarly, employment improved slightly, with four districts noting a modest uptick in hiring, seven reporting no change and one district reporting a drop in payrolls.

While the latest report showed little or modest change in activity, there was a notable uptick in prices as most districts reported modest price growth. However, several districts reported the pace of price increases quickened from the previous report. Input prices rose faster than sale prices, particularly in manufacturing and construction. With input costs rising faster than sale prices, multiple districts reporting challenges in passing along higher costs to consumers. With input costs rising and pricing power easing, companies may face additional pressures on profit margins. The friction between costs and the ability to raise prices may be heightened, as contacts in most districts expect potential tariffs would lead them to raise prices to end consumers.

The week ahead

Tuesday: The National Federation of Independent Businesses Small Business Optimism Index readings for February will be out before the opening bell. Last month showed some softening of optimism and a spike in uncertainty. We will watch to see if the fluid nature of tariff discussions has any impact on the outlook of business owners.

Wednesday: The Consumer Price Index report from the Bureau of Labor Statistics will be the big report for the week. Last month’s data showed core inflation rose, and over the past few months the reading has been stuck above the Fed’s 2 percent target. We will be digging into the data to see if last month’s rise was due to price adjustments going into effect for the new year or if core prices are showing any signs of easing.

Thursday: The latest readings from the BLS on its Producer Price Index will offer a look at changes in costs for buyers of finished goods for February. We will be watching to see if input costs continue to creep higher, which could put pressure on profit margins or slow the pace of disinflation.

Friday: The University of Michigan will release its preliminary report on March consumer sentiment and inflation expectations. Inflation reports have been on the rise in recent months and have started to move consumers’ views on “buying ahead” of potential price increases.

Follow Brent Schutte on X and LinkedIn.

Commentary is written to give you an overview of recent market and economic conditions, but it is only our opinion at a point in time and shouldn’t be used as a source to make investment decisions or to try to predict future market performance. To learn more, click here.

There are a number of risks with investing in the market; if you want to learn more about them and other investment-related terminology and disclosures, click here.