Economic Outlook

Growth

Employment

• Payrolls increased 151,000 in February
• Unemployment ticked up to 4.1%
• Wage increases were moderate

The US economy added 151,000 jobs in January, a solid result. The unemployment rate was little changed at 4.1%. As a benchmark, the US needs to add about 100,000 jobs per month just to keep up with population growth, so measures about that level indicate a healthy rate of hiring. Average hourly wages were up 4.0% year-over-year, which is not a rate of increase that would negatively impact overall inflation.

Most of the changes in the overall employment situation during this tightening cycle have occurred in job openings. In the early months following COVID, there were more than two job openings for every unemployed person; today, there is just under one. A reduction in job openings is much less painful to the economy and its participants than an increase in unemployment, a result that is very typical for a tightening cycle when the Fed is increasing rates to combat inflation.

Stricter enforcement of immigration laws may tighten the availability of labor. Such actions could increase the number of open positions and fuel additional increases in wages. So far, no such effect is showing up in the numbers. Industries that could see a greater impact from such policies include agriculture, construction, healthcare, and hospitality.

There may be challenges in the US economy, but those challenges are not presently showing up in the data relating to employment and unemployment.

Inflation

• February CPI softer than January at 2.8%
• Core CPI came in at 3.1%
• Inflation has stalled above 2%

Headline CPI came in at 2.8% in February, slightly lower than the 3% recorded in January. The “core” inflation number, which excludes food and energy, came in at 3.1%. Both numbers are above the Fed’s target of 2%. Improvements over the January numbers came from slower growth in food and energy prices as well as core goods and services. While the month-to-month numbers have been showing small moves up and down, sustained improvement in inflation has not occurred since mid-2024. Inflation appears stuck at levels above the Fed’s stated target. The broad measures of inflation were helped in January by a slight decline in gasoline and a leveling out of food prices, despite a sharp rise in the well-publicized price of eggs. Core inflation was helped by lower new car prices, as well as a slowing of price increases for used cars and trucks. Pharmaceuticals were flat. Shelter costs moderated slightly, especially in the form of rent expense. Overall, housing costs remain high.

The consumer’s perception of inflation remains elevated because prices remain elevated. Inflation only measures the rate of change in the overall price levels, not price levels themselves. Inflation could moderate down to the Fed’s 2% goal and prices would still be high relative to our pre-COVID experience.  Inflation has moderated a great deal since hitting 9% halfway through 2022, but for now, it remains stuck above the Fed’s target and prices remain high. New tariffs will add to the cost of imported goods and the cost of goods that incorporate imported parts or materials.

Interest Rates

• Federal Reserve is on hold
• Short-term target rate held at 4.25–4.50%
• Key 10-year Treasury rate has fallen to 4.25%

The Federal Reserve’s Open Market Committee met on March 18 and 19 and left their target for short-term rates unchanged. The upper bound for that target is 4.50%. It had been 5.50% last September, before the rate cuts in the fall of 2024. This is the second consecutive meeting where the Fed has left rates unchanged. In its press release, the Committee continued to describe the pace of economic activity as “solid;” it also indicated that inflation remains “somewhat elevated.” In perhaps the most telling change in their statement, they indicated that “uncertainty around the economic outlook has increased.”

The Summary of Economic Projections (SEP) was also released after this meeting. These summary statistics, which reflect each member’s views on future trends in the economy, are only released four times each year. The median forecast for GDP growth in 2025 was reduced from 2.1% to 1.7% by the members of the Committee. Their median forecast for core PCE inflation rose from 2.5% to 2.8% for the same period. The median forecast for unemployment at the end of 2025 increased from 4.3% to 4.4%—not a large change, but up from the current rate of 4.1%. The median forecast for rate cuts this year remained unchanged at two 0.25% cuts, but four members indicated an expectation for no additional cuts this year.

A combination of lower growth, higher unemployment, and higher inflation would pose a very tough dilemma for the Fed for the remainder of 2025. If inflation ticks higher, would they hold or even raise rates as they have in the past to combat inflation? Remember, their stated goal is 2% inflation. If growth declines and unemployment rises closer to 5%, would they cut rates to stimulate growth? Overall, the change in the SEP forecast gives off a whiff of stagflation—an ugly condition where growth stalls, but inflation remains elevated. The Fed regularly references its “dual mandate”—price stability (low inflation) and full employment. Stagflation, even in a mild form, would be the toughest set of circumstances for the Fed to address.

Overall monetary conditions remain somewhat restrictive, meaning that interest rates are still above where they would be if growth, employment, and inflation were in balance. The Fed is leaving rates where they are because they believe there is still room for improvement on inflation and because the labor market is not yet sounding alarms. A change on either of these fronts could change their posture.

Similar to other decision-makers in this economy, the Fed is on hold because of their own uncertainty regarding the direction and impact of new policies on the economy. The bond market is grappling with those same uncertainties. At this writing, the 10-year Treasury yield stands at 4.25%. It had been as high as 4.79% in mid-January and as low as 3.63% last September. The rate on the 10-year Treasury is the benchmark that sets most of the other interest rates in the US credit system. It is key to determining the rate for the 30-year mortgage.   

Markets

• Stocks take back their post-Trump rally
• Stock market broadening out, international gains ground
• Bonds earning yields above the inflation rate

Following Donald Trump’s election victory, the stock market staged a very impressive rally; the S&P 500 rose above 6,000 for the first time, and the Dow surpassed 44,000. Those post-election gains have since been wiped out as investors grapple with the administration’s sweeping new policies. At this writing, the S&P 500 is 5.5% below its level at the first of the year and 6.4% below its recent peak. Since that index was up over 25% in 2024, inclusive of dividends, for most investors, the current weakness is a give-back of prior gains. Much of the decline in the index has been led by the same short list of technology mega-cap stocks that led the bull markets of 2023 and 2024. To a certain extent, a broadening of support away from those names may be a healthy development for this market. If so, this is also a somewhat painful path to achieving that result. International stocks, which have trailed US stocks for most of the past two years, are suddenly showing positive results relative to our domestic markets. Several European markets have staged double-digit returns so far this year as the US market has lagged. Global investors are anticipating increased government spending in Europe, particularly in the area of defense. This anticipated spending is happening in the context of a relaxation of US support for Ukraine and the NATO alliance. Some part of the break in US stock returns could be attributed to the extreme valuations they had attained over the past two years. In the aggregate, the S&P 500 is trading at about 28 times the annual earnings of its component companies. While elevated multiples have become more typical in recent decades, the long-term average PE multiple of the stock market is closer to 16. 

Short-term bond yields declined with the Federal Reserve’s rate cuts at the end of 2024. They now stand at 4.36%. Intermediate-term rates had declined through September of last year in anticipation of Fed cuts, then rose through the last quarter of 2024 and into early January. For much of early January, the yield on the 10-year Treasury appeared headed for 5%. It peaked at 4.8% and has since settled back to about 4.25%, essentially even with short-term rates. The bond market will need clear and convincing evidence of restraint on deficit spending before settling into sustainably lower rates. In contrast to the recent period of ultra-low rates, intermediate bonds are now providing a yield that is meaningfully above the current rate of inflation. At these levels, they may once again play a constructive role in a conservative investor’s portfolio.

If we can help you navigate this changing business climate, please do not hesitate to contact your United Community banker. We appreciate your readership.