Behind the strong performance of the U.S. economy, has the impact of tariffs just begun?
According to news from the Chasing Wind Trading Desk, a recent research report by Citibank analysts Veronica Clark and others shows that despite recent market optimism fueled by expectations of tariff reductions, U.S. stocks have fully recovered from the declines following the tariff announcement on April 2. However, U.S. Treasury yields (especially the 2-year yield) have significantly declined, and the market is still digesting expectations that the Federal Reserve will cut interest rates by more than 80 basis points this year.
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At the same time, soft data has shown a clear weakening trend since the announcement of the tariff policy on April 2. The U.S. manufacturing PMI for April is slightly above 50, and the ISM manufacturing index released this week fell less than expected to 48.7. New orders and employment sub-indices have increased compared to March but are still in a contraction state.
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The report predicts that if tariffs remain at current levels for at least the next few months, the U.S. economy will experience three phases of impact: a &#34;buying spree&#34; temporarily boosts economic data, uncertainty leads to a slowdown in investment and hiring, and supply constraints trigger layoffs and price increases. This process may force the Federal Reserve to cut interest rates by 125 basis points this year, far exceeding market expectations.
<h2>Phase One: &#34;Buying Spree&#34; Temporarily Boosts Economic Data</h2>
Data shows that U.S. GDP declined by 0.3% in the first quarter due to a surge in imports, but final private domestic demand grew strongly by 3.0%, consistent with the growth pace of the past two years. This strong consumption and investment is at least partially related to tariffs.
The report states that after a slowdown in U.S. consumption data in early Q1, there was a rebound in March, and this strong spending may continue into April (and even May), as more consumers will make purchases in advance to avoid potential shortages or price increases due to tariffs. April auto sales slightly fell to 17.27 million but remained at a recent high.
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Citibank points out that the unusually strong investment in Q1 may also reflect a &#34;buying spree&#34; during the &#34;window period&#34; before tariffs. Data shows that investment in information processing equipment (such as computers) in the U.S. saw the highest growth since 1955; consumer goods imports surged in March, reaching a historical high.
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The report states that the &#34;buying spree&#34; may lead to strong economic data performance in the short term, but this growth is unsustainable, and U.S. GDP is expected to grow by 1.4% in Q2
<h2>Phase Two: Uncertainty Leads to a Slowdown in Investment and Hiring</h2>
By the second phase, the most direct impact of tariffs is a significant increase in uncertainty, which in turn leads to a pause in investment and hiring plans. Although economic activity data may temporarily remain supportive, the labor market may soon begin to show signs of weakness.
According to Citigroup's analysis, the hiring rate in the March JOLTS data remained flat at 3.4% (3.7% in the private sector). However, job vacancies declined in March and may continue to decrease, with high-frequency data showing that job postings began to decline rapidly in late April. Additionally, data from the job site Indeed indicates a significant drop in job postings since the announcement of tariffs on April 2.
It is noteworthy that the April non-farm employment data did not reflect signs of hiring weakness, with 177,000 new jobs added and the unemployment rate holding steady at 4.2%. The hiring intensity in the construction and leisure/hospitality sectors surprised analysts.
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However, the report emphasizes that the April employment data reflects the situation from the first two weeks of the month, prematurely reflecting hiring and firing decisions made after the tariff announcement on April 2. It is expected that the impact of hiring weakness on employment will be seen as early as May (with the potential for more layoffs among federal workers).
Furthermore, unemployment claims data has already shown early signs of deterioration in the labor market. As of the week ending April 19, the number of people continuing to receive unemployment benefits reached the highest level since the pandemic. If this level persists until mid-May, it could mean that the unemployment rate next month may rise to 4.4-4.5%.
The report also adds that students and recent graduates entering the labor market in the summer may pose additional upward risks.
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<h2>Phase Three: Tariffs Restrict Supply, Triggering Layoffs and Price Increases</h2>
The impact of tariffs on economic activity data will highly depend on the actual tariff situation in the coming months, as well as the extent of preemptive purchasing and planning by businesses. Citigroup states that the longer the tariffs last, the greater the risk that tariffs will directly lead to reduced supply and weakened activity.
Report data shows that the number of ships waiting to arrive at the Port of Los Angeles has begun to show signs of decline. This will lead to weakened activity in related industries such as trucking and transportation. Manufacturing may also experience early negative impacts, as shortages of certain inputs could lead to broader production halts.
Citigroup expects that signs of significant layoffs in these industries may be seen as early as late May or June. Challenger data indicates that planned layoffs due to tariffs have already begun to rise and may increase significantly in the coming months.
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The report states that by late summer/early autumn, the maximum impact of tariffs on consumer prices may become more apparent, with rising commodity prices potentially reflecting both the transmission effect of increased import costs and shortages of various goods, which could drive up the prices of substitutes.
Despite the core PCE inflation being weaker than expected in the first quarter, it slowed to 2.6% in March. However, the report anticipates that the impact of tariffs starting in February may first appear in the April inflation data, which is just two weeks away, although inflation is likely to remain primarily focused on commodity prices, while service inflation continues to slow.
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<h2>Federal Reserve Policy Outlook: Forced to Cut Rates Significantly</h2>
Although the timing and scale of tariff-related impacts are difficult to estimate, Citigroup believes that the evolution of hard economic data will be the ultimate factor determining when the Federal Reserve resumes rate cuts.
According to the bank's baseline scenario, by May, there will be sufficient weakness in hard labor market data (such as an unemployment rate increase of 0.2 percentage points or more), prompting the Federal Reserve to cut rates in June, with a total cut of 125 basis points for the year.
For the FOMC meeting scheduled for May 7, Citigroup expects the Federal Reserve to maintain the policy rate unchanged. Given that this meeting will not release quarterly economic forecasts, the statement may only change slightly, with the focus shifting to the post-meeting press conference.
The report predicts that, due to labor market indicators not having deteriorated significantly, inflation remaining above target, and uncertainty still being high, Chairman Powell may reiterate that the Federal Reserve is not in a hurry to lower the policy rate, but will still leave room for a rate cut in June in the statement, indicating that if labor market data deteriorates significantly, the Federal Reserve may take action

Citigroup believes that with tariffs remaining at current levels for at least the next few months, the U.S. economy will experience three phases of impact: a "buying spree" temporarily boosting economic data, uncertainty leading to a slowdown in investment and hiring, and supply constraints triggering a wave of layoffs and price increases. This process may force the Federal Reserve to begin cutting interest rates as early as June, with a total reduction of 125 basis points within the year, far exceeding market expectations

- The report from Citigroup analysts highlights that despite a strong U.S. economy, the impact of tariffs is just beginning, with expectations of significant interest rate cuts by the Federal Reserve.  
- It outlines three phases of economic impact: an initial boost from consumer purchasing, followed by a slowdown in investment and hiring due to uncertainty, and ultimately, potential layoffs and price increases as supply chains are affected.  
- The report predicts that if tariffs remain, the Fed may cut rates by 125 basis points this year, with the first cut likely in June, depending on labor market data.

The market is too optimistic! The impact of tariffs on the U.S. economy has "three phases," and the second phase is about to begin