Triple Play

The New 3-3-3

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It is not just President Trump expressing his opinion to the Fed; businesses are talking too. According to Fed Governor Waller, firms are trying to figure out how much of the tariffs they can absorb, and which costs to cut to minimize the damage to profit margins. If the larger 25% tariffs are implemented, Waller expects the labor force to be reduced. Unlike 2022, where firms reduced job openings but kept staff, “now, if labor demand pulls back…you will see employment start to drop.”

Governor Waller was told something else by executives, something quite important.

He said business leaders plan to assume one-third of the tariffs if they settle in the 10% to 12% range and expect their suppliers to eat a third. That means they will pass on the final third to their customers. While not ideal, that avoids the nightmare scenario of the Federal Open Market Committee (FOMC) forced to raise rates despite a slowing economy to counter rising long-term inflation expectations. If price inflation rises from a 4% tariff surcharge, consumers should not raise their long-term inflation expectations. Secondly, the FOMC will view this as a limited one-time bump to inflation—a manageable pass-through. That would increase the Committee’s confidence that they can ignore the inflation bump and focus on supporting growth should the unemployment rate rise.

This new 1/3^rd-1/3^rd-1/3^rd view differs from Treasury Secretary Bessent’s 3-3-3 plan of 3% growth, 3% increase in oil production, and a 3% budget deficit, but it, too, can result in improved optimism. If this consensus gains acceptance, it creates a framework investors can grab on to, increasing the visibility of economic forecasts post the 3-month tariff pause.

When things are this volatile, the long-term view is in flux, but it can also reset itself on a dime. Pave’s models are built for this type of rapidly forming market consensus. We are on the lookout for shifts in our factor scores.

Of course, if tariffs end up gravitating toward 25%, then all bets are off. Yet, it is critical to recognize that we could be approaching a turning point. We wrote that if stocks exhibit positive tone (meaning that it doesn’t fall on bad news), that is the “first sign of a market in repair.” China’s Friday morning denial to President Trump, saying that Washington and China were talking, would have caused a fast downdraft in equities just a week ago. The fact that markets held in shows that underlying optimism may be growing.

Xi Sees a Path to a Deal…With Europe

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What could cause the positive scenario above to stop dead in its tracks? If China successfully aligns with the E.U., Xi can prevent a unified front against China that would have extracted trade concessions. That would allow China to extend a trade war between Beijing and Washington indefinitely. Alternatively, one could take the other side of this argument: a successful negotiation between the EU and China could create a blueprint for a lasting settlement between America and China.

We hope that all three major trading spheres of the U.S., Europe, and China can come to the table in the spirit of reasonable cooperation. The order in which the trading partners form allegiances matters and can determine the path of stock prices.

Much is riding on how this “glass is half full/half empty” love triangle plays out. Europe and China have each made advances recently. Europe is talking about reducing EV tariffs that extend as high as 45% down to a more palatable level. Last week’s Shanghai auto show announced Chinese investment plans for Europe, including plans to build an EV research center in Germany. The research collaboration was welcome news for European automakers who want joint ventures with China, the clear leader in EV and battery technology. China has the added incentive to deepen its relationship with Europe to ease any supply chain pressures arising from an intensifying trade war with the U.S..

However, culture runs deep. The fact is that China has fallen short of being a dependable trading partner to Europe. European leaders will fly to Beijing in the second half of July, after Trump’s trade pause expires, to see if there is a need for a coordinated response to the U.S.. Our hope is that Europe and America can resuscitate their historical ties and present their own unified front against China before July.

Taking a step back, the introduction of tariffs has forced a much-needed dialogue between the EU and China. Europe is eager to see the Chinese alter their current industrial policy, especially if China begins to redirect U.S. exports toward the Continent. Thankfully, there is now a sense of urgency, and perhaps a road to compromise.

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Go With the Inflow

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Everyone loves gold and hates U.S. bonds. Last week, EPFR reported that physical gold funds enjoyed their biggest inflow since the firm began keeping records in 2007. Meanwhile, U.S. bond funds posted their largest redemptions since the pandemic 5 years ago, with high yield corporate bond funds seeing the biggest outflows. Short-term bond funds have seen continual inflows since the beginning of the year, and intermediate and longer maturity bonds have seen the opposite for several weeks. Asian and emerging market bond funds also experienced heavy selling.

We believe the key price relationship that could dictate equity exposure management is the U.S. 10-year Treasury note price vs. gold. That ratio has been falling since Trump’s first term and all through the Biden administration, hitting an all-time low early last week. Bonds need to stabilize relative to gold and begin to see inflows before equity investors can feel secure.

U.S. equity outflows did stop, leveraged bullish equity ETFs have seen a spike up in inflows, and high yield credit spreads continued to tighten, all illustrating a less fearful environment. An important technical indicator that triggers when the percent of advancing stocks surge within a two-week window after a major selling climax (Zweig Breadth Thrust) just gave a positive signal on last Thursday’s close. It is only the eighth buy signal since the 2009 lows, and it tends to forecast strong equity performance, both over near-term and long-term investment horizons.

Stocks cannot go up unless capital flows are positive, so we are closely watching the EPFR data across precious metals, fixed income, and equities. There are signs investors are expecting the tariff overhang will lift. If adverse news, such as the president expecting tariff revenue to “substantially reduce” income taxes, does not cause further U.S. equity and bond fund outflows, then the markets are on steady footing.

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What to Look for This Week

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(All times D.S.T.)

1.  Friday, May 2 at 2:30 p.m. the Employment Situation Report for April. March data showed employment rose by 228,000, and the unemployment rate was stable at 4.2%. The forecast consensus is for 140,000 but a drop in the unemployment rate to 4.1%.

2.  Tuesday, April 29 at 10:00 a.m. Job Openings and Labor Turnover Survey (JOLTS) for March. The Hirings Index has been at 3.4% for the last three months after hitting the lowest level since the pandemic of 3.3% in November. If hirings continue weak, any increase of above 4.5% in the unemployment rate triggers the Sahm Rule, indicating a recession. If that happens, it would be a legitimate recession signal because with immigration flows reversing, this signal would be caused by a lack of hiring that pushes the unemployment rate higher.

Also at 10:00, the Conference Board Consumer Confidence data for April. March Expectations fell a massive 10 points to 65 , a 12-year low. Anything below 80 is considered a recession is coming.

3.  Wednesday, April 30 at 10:00 a.m., Personal Consumption Expenditure Price Index for March. Consensus is looking for a 2.7% core PCE annual reading for March, but the Cleveland Fed forecasts 2.5% using their InflationNow model.

FOMC Voters Speaking:  The two-week Fed blackout period started Saturday until the May 6-7 meeting.

Earnings Note: Tuesday, April 29, Amazon and Visa both could reflect on consumer health. Wednesday, April 30, Microsoft and Meta along with QUALCOMM and KLA Corp. Thursday, May 1, Apple and Mastercard. Friday, May 2 Berkshire Hathaway.