Too hot? Too cold? Just right?

Good morning. President Donald Trump revved up the tariff rhetoric again yesterday, promising that his 25 per cent tariffs on imports from Mexico and Canada would go into effect next Tuesday, and that another 10 per cent would be added to existing China tariffs. All this on top of Wednesday’s promise of 25 per cent tariffs on Europe “very soon”. The market has again been left to wonder if the president was bluffing again. European stocks fell a per cent or so, with carmakers down a couple of points more. The key currencies moved, too, but not much. They remain in their 2025 trading range:

Does Trump mean it this time? Let us know what you think: robert.armstrong@ft.com and aiden.reiter@ft.com. 

The economic outlook

Earlier this week we presented an economic prediction matrix for year-end 2025, with employment and inflation as the variables. It looked like this:

What is the probability distribution across the boxes? As a reminder, we don’t think that the predictions rendered by this sort of exercise are particularly useful. Economic forecasting, to any useful degree of precision, is near impossible. The process of predicting, however, is very useful. Attempts at prescience force clarity about the present. 

Readers were very evenly split. On average, most thought that B — too hot — was the most likely outcome, but gave it a probability of only 1 in 3, with “stagflation” close behind.

The arguments for each the four outcomes, as we see them, are as follows: 

A: Just right

• The hard economic data is strong. Yesterday we got an upward revision to Q4 GDP. Manufacturing has started to expand after years of contraction. Unemployment is low, and jobless claims barely moved last week. 

• Monetary policy is restrictive and inflation will come down. Inflation is still elevated, and the last few reports have not been encouraging. But a similar thing happened early last year, before disinflation reasserted itself. This stuff takes time. 

• Trump is bluffing about tariffs and mass deportations. Despite a lot of noise, only China and steel/aluminium tariffs have been put in place. It’s possible that the other threats never come to pass. The same could be true for immigration; the huge wave of deportations is yet to crash

• Tax cuts and deregulation help just enough. Businesses get just enough of a leg up to keep nominal growth humming.

B: Too hot

• The hard data remains strong. See above.

• Trump’s tariffs result in higher prices. In last week’s ISM surveys and the University of Michigan consumer sentiment report, business owners and households said they already saw evidence of tariff-related price rises and expected more to come. Maybe this will be a one-time price shock and imports will be replaced quickly by substitute goods — but maybe not. 

• Deportations increase prices and hold unemployment down. Trump’s efforts to round up undocumented migrants raises prices, including wages, in sectors such as agriculture and construction. 

• Doge doesn’t matter. It is possible that Elon Musk, for political or logistical reasons, loses his war on the deep state and its effect on employment is limited.

• Tax cuts help too much. At this point no one needs reminding what very loose fiscal policy can do to prices. 

C: Too cold

• There are cracks in the economic data. Recent consumer sentiment reports didn’t come from nowhere. Walmart recently projected sales growth for this year barely above the current rate of inflation. While unemployment is low, low hires and quits imply economic uncertainty. The ISM services survey has slipped into contraction, and there is reason to think that the uptick in the ISM manufacturing is because of manufacturers trying to front-run tariffs and an inventory restocking cycle, rather than strong end demand. 

• Uncertainty kills demand and investment. Ambiguity is a good negotiating tactic and a bad economic strategy. 

• Lower fiscal spending puts pressure on profits. Government deficits have a way of showing up as corporate surpluses. If Doge does meaningfully shrink the budget, profit margins are likely to decline, and then . . . 

• Falling asset prices create a negative wealth effect. Everything is expensive. If that reverses, it will reinforce the slowdown. 

• Deregulation never comes: So far, the Trump administration has looked more like the Biden administration on corporate regulation than the market expected. Recently, his regulators endorsed FTC chair Lina Khan’s merger guidelines from 2023, much to Wall Street’s dismay.

D: Stagflation

• There are cracks in the economic data (see above).

• Tariffs raise prices and slow demand.

• Deportations increase prices and hurt growth: Immigration crackdowns could reduce real growth by as much as 0.4 per cent in 2025, according to Brookings. And the lack of cheap labour could bump up prices, particularly for food and construction.

• Federal lay-offs hurt. Torsten Slok of Apollo estimates that as many as 1mn government employees and contractors could lose their jobs — a 15 per cent increase to the current level of unemployment.

Unhedged is split on which scenario is the most likely. Rob leans towards too hot: the recent bad economic data feels like a blip and inflation really looks sticky, especially with tax cuts coming. Aiden leans more towards stagflation: inflation is sticky and tariffs will make it stickier, meanwhile, the economy is already slowing, with more headwinds to come. Let us know what you think.

One good read

A Russian quandary.

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