Vital Statistics:
Stocks are lower as tariffs kick in and countries retaliate. Bonds and MBS are up.
The manufacturing economy weakened in February, according to the ISM Manufacturing Report. That said, manufacturing is in expansion mode after spending the last two years in contraction. New orders and backlog are contracting, while prices for commodities are rising. Uncertainty over tariffs are a major issue.
“U.S. manufacturing activity expanded marginally for the second month in a row in February after 26 consecutive months of contraction. Demand weakened, while output stabilized and inputs, for the first time in several months, contributed to PMI® growth.Factory output marginally expanded compared to January, indicating that panelists’ companies are being cautious about ramping up output in the face of economic headwinds. The Employment Index moved back into contraction, as panelists’ companies continued to release workers. More companies cited ‘attriting down’ as the best process, with destaffing not as urgent as it was in the second half of 2024. Inputs — defined as supplier deliveries, inventories, prices and imports — revealed the first signs of supplier difficulties due to some pull-forward deliveries and discussions about who will pay for tariffs. Inventories recovered somewhat as a result.
“Demand eased, production stabilized, and destaffing continued as panelists’ companies experience the first operational shock of the new administration’s tariff policy. Prices growth accelerated due to tariffs, causing new order placement backlogs, supplier delivery stoppages and manufacturing inventory impacts. Although tariffs do not go into force until mid-March, spot commodity prices have already risen about 20 percent. Twenty-four percent of manufacturing gross domestic product (GDP) contracted in February, down from 43 percent in January. The share of manufacturing sector GDP registering a composite PMI® calculation at or below 45 percent (a good barometer of overall manufacturing weakness) was 2 percent in February, a 6-percentage point improvement compared to the 8 percent reported in January.
Construction spending fell 0.2% MOM and rose 3.3% YOY in January. Residential construction fell 0.4% MOM and rose 3.1% YOY. Multifamily construction was down 12% on a YOY basis, while single family was down marginally.
The ISM Report and Construction spending report caused the Atlanta Fed’s GDP Now Model to forecast a 2.8% contraction in Q1. The Fed Funds futures are becoming more dovish with the markets now seeing a 11% chance of a rate cut at the upcoming meeting. For the December futures, the most likely outcome is 3 rate cuts, which would put the Fed Funds rate close to r-star, or the neutral rate of interest.
St. Louis Fed President Alberto Musalem is becoming concerned about growth.”The outlook for continued solid economic growth looks good, the labor market is healthy, and financial conditions are supportive. But recent data have been weaker than expected, especially consumer spending and housing market data, posing some downside risk to growth,” Musalem said in comments prepared for delivery to a National Association for Business Economics conference.
“Recent anecdotal reports from business contacts are more mixed, and some measures indicate that business activity has slowed, suggesting increased caution at least among some firms,” he said.
“While I continue to expect the economy to grow at a good pace in coming quarters, I would become concerned if we begin to see more evidence of a consumer pullback or a dampening of business confidence and investment plans,” Musalem said.
Friday’s jobs report looms large for the bond market. The Fed is happy with the current 4% rate of unemployment. It won’t tolerate it moving up much, especially with inflation back on the downtrend.
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