Duolingo

Actionable Data: Given that political policy lurches negative one day and then positive the next, setting investment policy has been difficult. Thankfully, we will receive clarifying data this week from NVIDIA earnings and from January’s Personal Consumption Expenditure Price Index, the Fed’s favored inflation metric. This will provide investors with a clearer picture of the direction in which markets could go. The market’s reaction off those data points should clarify portfolio positioning, at least from a fundamental perspective. 

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Conflict Resolution?

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The Dynamic Duo of Trump and Musk are making waves, and at least two could crash on shore. The president wants to craft a trade deal where China agrees to buy more American goods this year. This could be a problem because President Xi had already refused President Trump’s proposal five years ago to buy an additional $200 billion of our imports. If Xi refuses once again, will a more confident Trump create an escalating trade war? Trump’s vision for China building factories on American soil is at odds with those of Rubio, Navarro, and Waltz, who view Chinese investment as a security risk. Hopefully, the result of all this does not conclude with an unresolved trade tiff reminiscent of the first Bush administration's failure to get Germany to buy our goods. That clash led to a calamitous stock market selloff. Shooting high in trade talks is a good negotiating tactic, but only if it doesn’t make the situation worse if you do not get what you want.

Another potential collision waiting in the wings is the need to resolve the budget before the Continuing Resolution expires on March 14. Because many Republicans are strongly against excessive spending, House Speaker Mike Johnson, in the past, had to cut deals with the Democrats to avoid a shutdown. However, because Musk is seen as overstepping Constitutional boundaries, it is unlikely that Democrats will cooperate now, thinking that whatever they agree to, Musk could plow over. That means the way to avoid a government shutdown is to include deep budget cuts to win over holdout Republicans. The problem with that tactic is it will be opposed by the majority of House Republicans whose constituents do not want social safety net programs getting scaled back. With 38 House Republicans voting against the December 2024 Continuing Resolution and only a three-vote majority, the math points to a shutdown.

The larger fight over the debt limit should get resolved before the government runs out of funds this summer, but the rating agency Fitch thinks the tax cut and spending decisions will “be reached on an ad hoc, issue-by-issue basis, underscoring the U.S.’s deterioration in governance on fiscal matters.” The markets will not appreciate the coming turbulence.

Minutes Minutiae

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We are starting to hear static from the Fed about a not-so-dynamic duo: immigration and tariffs. The minutes of the Jan 28-29 Federal Open Market Committee (FOMC) meeting repeated concerns from December that the administration’s policies could raise inflation. We mentioned that we believed the most important data from last week would be those minutes because the January FOMC statement left out December’s language that “Inflation has made progress toward the Committee’s 2 percent objective.”

The November minutes, held just following the election, were still looking the other way, describing the “various factors likely to put continuing downward pressure on inflation.” However, in December, FOMC members first underlined their concern about the inflationary problems posed by Trump’s policies, and the January minutes took it one step further:

Participants cited the possible effects of potential changes in trade and immigration policy and the potential for geopolitical developments to disrupt supply chains…to hinder the disinflation process.

Supply chain issues were the post-pandemic inflationary driver as the supply of goods was scarce, and now FOMC voters are concerned that tariffs will cause similar shortages in a trade war. This renewed inflation anxiety is what caused the removal of the phrase that inflation is no longer making downward progress. Going deeper into the weeds of the December minutes, only one-third of FOMC members said they considered inflationary tariffs when generating the consensus 2.5% core inflation forecast for yearend 2025. That means when they revise those 2025 and 2026 inflation forecasts at the March 18-19 FOMC meeting, there is a strong chance of a much higher inflation outlook, which would pressure yields higher and stocks lower.

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The Reich Stuff

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JD Vance recently scolded the German government for not listening to the faction of its citizens who were turning more far-right. German voters spoke Sunday, and they did lean right, but not as far as Vance hoped. While the far-right AfD party doubled its representation in Parliament, they received fewer votes than what was expected from their polling numbers. This proved Musk’s and Vance’s AfD endorsements worked slightly against them. President Trump remarked that the vote was a mandate against immigration, considering that the largest losers were the center-left SPD and liberal FDP, who won a combined 37% in the last election and now received just 21% of the vote. The SPD, who won four years ago, had its worst showing Sunday in over a century.

The vast majority of Germans are relieved that the AfD, who campaigned for a break from the European Union and the Euro currency, will be isolated as an opposition party. Incoming Chancellor Merz of the CDU campaigned on less regulation and stricter immigration controls and is hoping for a return of the Merkel-era coalition with the SPD, and it appears they can cobble a Parliamentary majority together. Importantly, shortly after the election results, Merz forcefully stated he wanted Germany and Europe to reach “real independence” from an “indifferent” U.S. government. The newly elected leader was quite clear, saying that Vance’s meeting with the head of the AfD and Musk writing in a German paper that the far-right represented the “last spark of hope” was no different than Russian election interference. 

This morning, Merz said Germany must consider the “worst-case scenario” moving forward with the U.S., which we believe will be detrimental to America as Europe becomes less dependent on Washington. The dual desire to contain an evolving AfD and a combative Washington could galvanize the cooperation between mainstream German parties and result in elevated fiscal spending that could calm world markets and push all of European equity markets higher in the near-term.  

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What to Look for This Week

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1. Friday, February 28 at 8:30 a.m. E.S.T. January Personal Consumption Expenditures Price Index. The core inflation reading has been 2.8% for the last three months, and the Cleveland Fed’s Inflation Nowcasting forecast is for 2.7%. It is often a market mover, but expectations are 96% for no rate change at the March 18-19 FOMC meeting, so the release could be a non-event aside from a possible relief rally.

2. Tuesday, February 25 at 10:00 a.m. E.S.T. Conference Board Consumer Confidence report for February. We will first look at inflation expectations to see if they are still elevated, like the University of Michigan survey, which was revised higher to 3.5% Friday, even higher than the already elevated 5-year inflation expectations of 3.3%.

3. Thursday, February 27 at 5:00 a.m. E.S.T. Eurostat Consumer Inflation Expectations for February. The series has been rising since its low reading in July 2023, and given the reality of approaching tariffs, we want to see if heightened U.S. inflation expectations are spreading to Europe. Also Thursday: Tokyo February CPI at 6:30 p.m. E.S.T. and 20 minutes later, Japan Retail Sales for January. Both numbers can affect the timing of a potential rate hike. 

FOMC Voters Speaking: Only non-voter Raphael Bostic, President of the Atlanta Federal Reserve Bank at noon E.S.T. Wednesday, February 26.

NVDA quarterly earnings Wednesday, February 26, after the equity market closes.