Economy, The Fed and Rates
June 3, 2025
The Economy, the Fed, and Rates…
Economic Data
- Trade Disruption: U.S. goods imports fell by the most on record in April, plunging by nearly a fifth as President Donald Trump’s tariffs prompted companies to halt shipments. The 19.8% drop was the largest in data dating back to 1992.
- Inflation Remains Subdued: The personal consumption expenditures price index, excluding food and energy, rose 0.1% from the previous month. Compared with a year earlier, the so-called core inflation gauge rose 2.5% from April 2024 – the smallest annual advance in more than four years.
- Consumer Sentiment Mixed: The University of Michigan’s final May sentiment index at 52.2 remained near record lows, though long-term inflation expectations fell to 4.2% – the first decline since December.
- Q1 GDP Contraction: The U.S. economy shrank 0.2% in Q1 2025 (revised from -0.3%), marking the first contraction since 2022. Consumer spending grew just 1.2%, down from an initial estimate of 1.8% and the weakest pace in almost two years.
- Patient Stance: Fed officials broadly agreed that heightened economic uncertainty justified their patient approach to adjusting interest rates. The Fed is “well positioned to wait for more clarity on the outlooks for inflation and economic activity.”
- Stagflationary Concerns: Fed staff see risks of weaker growth combined with higher inflation from tariffs. The staff forecasted the labor market to weaken “substantially,” with the unemployment rate rising above its so-called natural rate this year and remaining elevated through 2027.
- Rate Cut Prospects Dimmed: Markets now expect fewer rate cuts in 2025 than previously anticipated, with Fed officials wary of tariff-induced inflation pressures.
- Private Credit Market Concerns: The Fed is debating whether it should regulate the rapidly growing $1.7 trillion private credit market, which operates largely outside its oversight. Some officials warn of systemic risks reminiscent of pre-2008 CDO structures, while others argue the risks are overstated.
Treasury Yields & Dollar Dynamics
- Correlation Breakdown: The traditional positive correlation between Treasury yields and the dollar has broken down. Since Trump’s “liberation day” tariffs were announced in early April, the 10-year yield has risen from 4.03% to 4.40%, while the dollar has dropped ~5% against a basket of currencies. Michael de Pass, global head of rates trading at Citadel Securities, noted: