Change of Call: One Fed Cut in 2025 as Tariffs to Hit Growth, Inflation

Summary

• NFPs were higher than expected though the trend remains unclear.
• Labour supply growth remained weak.
• Most measures indicate unchanged labour market utilization (i.e., full employment).
• Real wage growth had been accelerating but is about to slow due to tariffs-induced inflation acceleration.
• I am changing my Fed call to one 2025 cut due to the impact of tariffs on growth and inflation as well as to the Fed’s hawkish reaction function.

Change of Fed Call to One 2025 Fed Cut

Market Implications

• I expect the Fed to cut once in 2025, against markets pricing about cuts.

NFP Above Expectations

March payrolls were 228k, above consensus 140k, though January was revised down by 34k to 117k (Table 1). Sam’s model had predicted a small positive surprise.

Labour Demand Remains Choppy

Friday’s data surprised on the upside, following two negative surprises. Overall and despite the benchmark revisions, headline NFPs remain choppy.

• 3m average was down but the 6m average was unchanged (Chart 1).
• Public employment increased by 9k, with a 23k increase in state employment offsetting a 14k decrease in federal employment. Large-scale buyouts and layoffs of federal employees could take a few more months to appear in the data (Chart 2).
• Employment increased by 201k in in the HH survey and by 292k in the HH survey adjusted for payrolls definitions (Chart 3). HH survey employment estimates remain biased downward by the Census Bureau underestimating immigration.
• JOLTS net hiring rate (= hires – quits and layoffs) remained aligned with the 2019 average (Chart 4). Gross labour market flows (hires, layoffs, quits) have fallen, which I think reflects employers efforts to limit turnover, following the pandemic labour shortages. Overall though, JOLTS data still shows robust labour demand.
• March average weekly hours were unchanged from February and remained well below pre-pandemic (Chart 5). However, this reflects largely stronger post-pandemic preferences for part-time work (Chart 6). Also, total hours (AWH *NFP) remained on an upward trend.

Anaemic Labour Supply

Labour supply fundamentals remain weak:

• Total labour force increased by 232k MoM, but the prime age (25 to 54 years) labour force contracted by 132k MoM (Chart 7).
• Participation increased 10bp MoM but remained on a downward trend (Charts 8 and 9).
• Despite the Trump administration closing the Southern border and starting large-scale deportations, the share of migrants in the labour force was roughly unchanged (Chart 10). Furthermore, Friday’s high NFP print suggests immigration is still adding to labour supply.

Full Employment

Overall, the labour market remained at full employment:

• Unemployment rose by 1bp relative to February but rounded up to 4.2% vs 4.1% in February. It has remained around 4%, a historically low number, since mid-2022 (Chart 11). Employment-to-population ratios were roughly unchanged and remain near post-pandemic highs (Chart 11).
• Unemployment claims have remained stable, with few claims from federal employees so far (Chart 12).
• Spread between minorities and white unemployment remained near or below 2019’s average (Chart 13).
• Unvoluntary part-time work fell 10bp following February’s 30bp increase. It remains near the 2019 average (Chart 14).
• Share of unemployment accounted for by labour market entrants or re-entrants remained stable, a sign jobs are abundant enough to make it worthwhile to job search (Chart 15). The share of unemployment accounted for by job leavers has been falling since the pandemic, which could reflect efforts by employers to lower turnover (Chart 15; Chart 4 here).
• Among job losers, the share of temporary layoffs has decreased, which could also reflect employers’ efforts to increase employee retention (Chart 16).
• JOLTS ratios, unemployment and hires relative to vacancies, have stabilized near 2019’s average (Chart 17).
• Unemployment duration remains near 2019’S average (Chart 18).

Real Wage Growth to Slow

Slowing headline inflation has brought about an acceleration in real wage growth. This is about to reverse.

• March wage growth aligned with expectations at 30bp, but January was revised down to 20bp MoM from initially 30bp. Nominal wage growth has been around 4% for about 1.5 year (Chart 19).
• With slowing headline inflation, real wage growth has increased to about 1.25% (Chart 20).
• The administration wants to see faster real wage growth for lower income Americans. However, lower wage growth has been slowing relative to higher wages (Chart 21).
• The tariff increases will lift inflation. Because nominal wages adjust slower than prices, real wage growth will fall (Chart 22).

Market Consequences

Following Wednesday’s tariff announcements, Friday’s NFP and Chair Powell’s speech, I am changing my Fed call. I am now expecting one 2025 Fed cut, from previously no 2025 cut.

The reasons are:

• Friday’s payrolls show the economy was at full employment before the tariffs.
• I expect the tariffs to cause a growth slowdown rather than an economy-wide recession:
  • While a manufacturing recession is likely, manufacturing represents only about 10% of the US economy.
  • HH and businesses balance sheets remain strong on average.
  • A fiscal stimulus appears increasingly likely.
  • The administration could strike deals with trading partners and lower tariffs.
• In Friday’s speech, Powell made clear his overarching objective was to prevent the de-anchoring of long-term inflation expectations. With inflation above target and about to rise further, this suggests the Fed will cut late and little in response to economic weaknesses.

I will develop these views in future research. Meanwhile, markets are pricing four 2025 cuts.

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