Financial News for the Week of February 7th, 2025

This week was anything but boring for financial news. On Monday, an 11th-hour deal was reached to delay tariffs on Canada and Mexico for a month. However, while Canada and Mexico were spared, China was not, as an additional 10% tariff was imposed on all imports from the country.

The prospect of tariffs being imposed on North America in a month, or in April when the review of current trade policies is completed, looms large. Financial markets have largely recovered from their initial knee-jerk reaction to the tariff announcement, with the S&P 500 paring back losses by the end of the week. However, inflation expectations over the next two years have risen (Chart 1) while bond yields have declined. This points to investors’ concerns that tariffs will accelerate inflation and slow economic growth.

Businesses’ uncertainty about the looming tariffs were reflected in the trade data. The U.S. trade deficit widened sharply in December – the largest one-month increase since the early 1990s. Imports surged as companies rushed to ramp up inventories ahead of potential tariffs. Last month’s sharp increase in the trade deficit is likely temporary, but trade policy uncertainty will continue to affect trade flows throughout the year. Uncertainty about tariffs also clouds the outlook in the manufacturing sector, particularly in industries such as auto manufacturing (report). Even though the ISM manufacturing index has continued to improve in January, rising for the third consecutive month and finally moving into expansionary territory, supply chain disruptions could dent the sector’s nascent progress.

Activity in the services sector continued to expand robustly in January, although it dialed back a notch. The services sector is less exposed to trade than manufacturing, but it is not immune. The prices paid subcomponent remains elevated, and any supply chain disruptions and higher input prices could reignite inflationary pressure.

Additional inflationary impetus could also come from the labor market. Today’s employment report showed that the U.S. economy added 143k jobs in January. This is considerably less than December’s tally (+305k), but still a solid outturn, particularly when combined with a slight decline in the unemployment rate and an uptick in wage growth. Moreover, wildfires in Los Angeles and a cold weather spell nationwide could have also weighed on employment, suggesting a bounce-back next month could be in the cards. Lastly, revisions through the fourth quarter were notably higher, adding an extra 101k jobs to the previously reported figures and suggesting that hiring momentum was even stronger at the end of last year than previously thought (Chart 2).

With inflation progress having stalled in recent months, wage growth showing staying power and heightened uncertainties on how far the new administration will go on its policies, the Fed is likely to remain more cautious. Next week’s inflation report will likely show that the Fed’s patience is justified, as inflation remains persistently above the Fed’s 2% target.