Fed Cuts, Tariffs and Jobs. Oh My.
Clients of the Firm,
In The Wizard of Oz, Dorothy, Scarecrow and Tin Man are walking through the woods on the way to Oz and start to get scared. They are primarily concerned about lions and tigers and bears. In short, known risks in the dark forest. The Cowardly Lion menacingly shows up, but Dorothy slaps him on the nose and the risk of harm abates as his cowardice is revealed.
This week, the Fed trimmed its policy rate by 25 basis points taking the fed funds target to 3.50%–3.75%. Simultaneously, the Fed announced a renewed program of short-term Treasury bill purchases to shore up reserves and market functioning. Three policymakers dissented, and the post-meeting materials made clear the FOMC wants to leave room to judge incoming data rather than telegraph a predictable path of subsequent cuts.
If you look closely through the trees, you can see why the Fed acted, slapping the proverbial nose of unemployment. Labor-market momentum has slowed and headline indicators are sending mixed signals. Private payroll metrics showed a surprise decline in November per ADP’s report, while job openings edged up only modestly after September’s surge. An amalgamation of alternate indicators suggests the unemployment rate is drifting around the mid-4% range. At the same time, weekly initial jobless claims recently fell to a more than three-year low. This read was a robust outlier when compared to weaker private-payroll measures and a rise in announced corporate job cuts for the year. The labor market looks less overheated than it did a year ago, but it isn’t collapsing and that ambiguity appears to have pushed the Fed toward an incremental cut rather than a more aggressive move.
Two elements of the Fed decision are worth flagging for investors and policymakers. First, the quarter-point cut is in the target range. It’s modest, and the post-meeting summary (the dot plot and statement language) accommodates only gradual further easing. Second, the Fed said it will start buying Treasury bills (an initial program announced to begin this week) to manage reserve conditions and smooth money-market functioning. That operational step is less about stimulus and more about market functioning and keeps the Fed’s control of short-term rates intact as the liquidity backdrop tightens during the year-end. The Fed sees softening in labor demand but is not convinced the economy needs a large dose of accommodation against a backdrop of high labor productivity.
Due to the fall government shutdown, we have been using alternative data to analyze recent economic developments. ADP’s private payrolls showed weakness in November, alternate high-frequency measures and some private data vendors had job losses in certain sectors. That said, weekly jobless claims are unusually low and JOLTS still shows millions of openings. Policymakers have to make decisions in that shroud. In our view, that is why the Fed’s language emphasized data dependence. A large data dump is expected next week from the shutdown lag which will provide more insight.
On the federal budget front, tariffs have raised customs receipts, helping pare the headline deficit. Customs duties were unusually large in November, contributing to a much smaller monthly deficit versus a year earlier. That said, the Congressional Budget Office (CBO) and independent analysts have repeatedly trimmed earlier “tariff windfall” estimates after updating methods and accounting for the economic drag tariffs create. According to Reuters, recent CBO and watchdog updates cut multiyear revenue projections by roughly a trillion dollars from earlier forecasts. Consensus from the CBO is that tariffs bring receipts today, but they can reduce growth and import-driven productivity gains in the future. This effect reduces the net fiscal benefit over the medium to long term.
This glide path matters for monetary policy. Tariffs are inflationary and they raise prices for import-dependent businesses and consumers. In addition, the growth drag and uncertainty they create can slow hiring and investment. While tariffs improve the total revenue receipts of the Federal government, those benefits can be at least partially offset by inflation while simultaneously softening demand and employment. For the Fed, this dichotomy is challenging. It reduces clarity about whether to increase rates to fight inflation or to ease because growth and jobs are slowing. Hence, the Fed’s careful posture.
We expect more ambiguity in 2026. The Fed has signaled a willingness to cut further, but only as incoming data justify it. The current data remains a cocktail of conflicting signals. We expect labor markets to stay in a “no-fire, no-hire” limbo due to AI productivity gains. Further, we anticipate hiring will be cautious, layoffs concentrated in sectors undergoing tech disruption and the unemployment rate to remain relatively stable for 2026. This would in turn lead to a range-bound investment grade bond market for the coming year.
For the forward year, monetary policy is wrestling with a patchwork economy. This framework includes tariffs that help the Treasury’s budget while dragging long-run growth, labor data that are ambiguous, and stock markets concentrated in a handful of mega-cap winners near all-time highs. The Fed has taken a modest step toward easier policy this week. To be clear, it is a move made in a dark forest on the yellow brick road to Oz. Hopefully, we will only encounter the Cowardly Lion versus other threats that could take a bigger bite out of invested assets. Our view remains cautious optimism considering this backdrop and our equity portfolio actions will continue to be constructive with a healthy dose of risk management. The reason for this optimism is that productivity gains from AI and the requisite infrastructure (tech, data center, energy etc.) spend to support it are creating an earnings dynamic that should overcome the uncertainty of monetary policy. The ambiguity of rate levels balancing employment and price stability may keep interest rates range bound and thus less implicative to other asset prices than in recent years.
We appreciate the opportunity to serve as your portfolio manager and advisor and wish you a happy and healthy holiday season and New Year.
Sincerely,
Peter Wernau
CEO
Wernau Asset Management
30 Western Ave, Suite 206
Gloucester, MA 01930
Direct: 978-325-6049
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