Are the Impacts of Tariffs About to Come Into Focus?

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Equities lost ground last week as President Trump announced plans to slap 35 percent tariffs on goods from Canada and released letters written to several other smaller trading partners detailing tariff rates far higher than the current 10 percent baseline in effect globally. Over the weekend, Trump also announced 30 percent levies on products from Mexico and the European Union. The newly announced import duties are scheduled to go into effect on August 1. The renewed tough rhetoric from the White House disrupted the narrative many investors have embraced during the past several weeks of a fading trade war that would result in agreements that set levies well below the rates unveiled April 2, on so-called “Liberation Day.” While we believe that final import taxes are far from settled and that negotiations could stretch beyond the administration’s August 1 deadline, the latest twists serve as a reminder that the president remains committed to using tariffs as a tool in his effort to recast the global economy and the role of the U.S in it. Volatility in the market following the newly announced rates was consistent with reactions by investors since early April.

Trade headlines have driven market movements since the levies were first unveiled because investors are trying to gauge the impact they will have on economic growth and inflation. While it is likely that news on the trade front will continue to move the markets in the weeks ahead, investors may also start to get a glimpse of how the higher trading costs are being shouldered across the economy.

As we’ve noted in previous commentaries, anticipation of tariffs led to consumers and businesses buying ahead of expected price increases. This change in behavior has likely resulted in distortions in everything from business investment to an uptick in inflation at the beginning of the year followed by mild readings for the last few months. However, it is likely that businesses that stocked up on inventories ahead of the tariff announcements have worked through some of the excess supply and are starting to restock with items that now carry higher duties.

As the impact of the tariffs begins to work deeper into the economy, investors should get a better sense as to whether what is being captured in the soft data will translate into changes to hard data. The picture currently painted by hard data suggests a solid but slowing economy, with falling consumer spending, low unemployment but little appetite for hiring, and easing inflation. Meanwhile, soft data measures—such as last week’s National Federation of Independent Businesses Optimism Index and recent purchasing manager indices from the Institute for Supply Management and S&P Global—highlight rising input costs and prices charged on both the services and manufacturing sides of the economy.

While we believe it is likely that tariffs will lead to price increases, it is impossible to predict with certainty how the burden from the new levies will be shouldered among suppliers, manufacturers and consumers. It is likely that each group will end up paying a portion of the tariffs. The way the added costs are divided among the groups will likely have a meaningful impact on the economy and markets going forward. As such, the next few months could prove critical to better gauging the impact of tariffs as well as the likely path forward for the Fed. Specifically, this week’s Consumer Price Index from the Bureau of Labor Statistics could offer an early glimpse of whether the levies are creating upward price pressure, as is widely expected. Likewise, with earnings season kicking off this week, we will be looking for signs of whether business has absorbed the higher trading costs or tried to pass them on to end customers. We’ll also get a better idea of how businesses expect the tariffs will affect earnings going forward. Finally, this week’s retail sales data comes out and could help answer the question of whether the recent string of reports showing consumers tightening their belts has continued and is becoming an enduring trend.

To be sure, a definitive picture of the impact of duties on inflation and economic growth may not become clear for several months. Add in the potential stimulative effects of deregulation and the yet to be seen bond market’s reaction to the recently passed Republican tax and spending bill, and it's reasonable to expect that the markets could face heightened uncertainty for an extended period.

While the uncertainty remains high, the answer in dealing with unpredictability in the economy and markets is unchanged. We do not believe it calls for dramatic changes to your investment plan. Instead, the current environment serves as a valuable reminder that an unpredictable future will lead to unpredictable opportunities for investors in the intermediate and long terms. Capitalizing on these unforeseen opportunities is best done through diversification. This approach was validated during the other periods of extreme uncertainty, such as during COVID and the Great Financial Crisis before that, and we believe it will prove to be a prudent approach during the current economic changes.

Wall Street wrap

Small business optimism improves: The latest data from the National Federation of Independent Businesses shows that optimism among small businesses held mostly steady in June, easing 0.2 points to 98.6 and still slightly above the 51-year average of 98. Meanwhile, the Uncertainty Index fell to 89, down five points but still elevated compared to historical norms.

A closer look at the report shows that while optimism remained relatively strong, actual business conditions remained lackluster. When asked to rate the health of their businesses, 35 percent said fair (an increase of seven points), and 7 percent categorized it as poor, which marked a three-point increase from the prior month. Conversely, the portion of businesses that rated the health of their companies as excellent fell six points, as did those who rated the health of their companies as good.

Sales for small businesses remain weak, although the latest survey shows they were “less bad” in June, with the latest reading showing 5 percent more businesses (eight points better than in May) reporting declining sales than reporting flat or rising purchases. Against these still weak sales levels, selling prices continue at historically elevated levels, with 29 percent of respondents noting higher selling prices over the past three months (up from May’s reading of 25). For further context, with the exception of February of this year, June’s 29 percent is the highest level since October 2023. Additionally, 32 percent plan to raise prices in the next three months, an increase of one point from the prior reading. Meanwhile, labor costs for businesses climbed, with 33 percent of respondents reporting they raised compensation in the prior three months. This figure is up from 26 percent in April and is still at elevated levels on a historical basis. However, the latest survey results show the portion of businesses expecting to raise wages in the next three months declined by one point to 19 percent.

Elevated wage growth and slow sales have translated to generally slow earnings for small businesses since COVID. The latest reading shows a net 22 percent of business owners have seen their earnings shrink over the past three months, an improvement of four points from May’s reading and continuing a weak trend in profits by historical standards. Among owners reporting lower profits, 40 percent blamed weaker sales, 17 percent cited the rise in cost of materials, 10 percent pointed to price changes they charge for their goods and services, and 7 percent cited labor costs. All of this has led to tepid hiring by companies.

In total, 8 percent more businesses cut payrolls than added or held staff levels steady during the past three months. The portion of businesses expecting to hire in the next three months rose modestly in June. The latest results show 13 percent of companies expect to add to payrolls, an increase of one point from May. Those that are hiring are having a harder time, with 36 percent indicating they had positions they could not fill, up two points from May and the highest level in three months. Finding qualified help remains a challenge, with 50 percent of those hiring reporting a lack of qualified candidates, an increase of two points from the prior month.

Job market holding steady: The latest Nonfarm payroll report from the Bureau of Labor Statistics (BLS) released before the July 4 holiday showed 147,000 new jobs added in June, with just 74,000 positions added in private industry. Of the new jobs captured by the Nonfarm data, 73,000 were in state and local government, which is typically unaffected by the economy. Meanwhile, manufacturing, which is sensitive to the economy, saw 7,000 positions lost, bringing the two-month total of losses to 14,000. The diffusion index (which measures the portion of the 250 industries covered by the report that added jobs versus those in which employment is unchanged or declining) declined to 49.6 percent in June versus May’s revised level of 51.8 percent. This marks the second time in the past three months that fewer than half the industries surveyed reported job gains. Since March, the trend in one-, three- and six-month diffusion readings has been generally weakening.

The BLS’s other jobs report, the Household survey, showed the unemployment rate easing to 4.1 percent and 93,000 more people employed in June than in May. The decline in the unemployment rate came as the labor participation rate declined to 62.3 percent from 62.4 percent. The result of the lower participation rate was a decline of 130,000 in the size of the civilian workforce.

Continuing jobless claims rise: The latest data from the Department of Labor shows that continuing jobless claims (those people remaining on unemployment benefits) stand at 1.965 million, up 10,000 from the previous week’s revised total and the highest total since November 2021. The four-week rolling average of continuing claims came in at 1.955 million, an increase of 3,500 from last week and also the most since late November 2021. Meanwhile, initial jobless claims were at 227,000, a decline of 5,000 from the previous week’s revised total. The four-week moving average of initial claims numbered 235,500, down 5,750 from last week’s revised total. As we’ve noted in prior commentaries, we believe continuing claims are a more reliable indicator of the labor market, as they measure workers who are facing long-term challenges in finding a job and, as such, filter out some of the temporary noise that can be found in initial claims data.

The week ahead

Tuesday: The Consumer Price Index report for June from the BLS will be the big report for the week. Recent inflation readings have been muted. We will be digging into the data to see if the slower pace reported last month continued or if higher costs for some businesses, which have been captured in recent survey data, have translated to higher prices for consumers.

Wednesday: The Federal Reserve will release data from its Beige Book. The book provides anecdotal insights into the nation’s economy, and last month’s report showed slowing growth and declining demand for workers. We will be watching to see if this trend continues.

The latest readings from the BLS on its Producer Price Index will offer a look at changes in costs for buyers of finished goods for June. We will be watching to see if input costs continue to creep higher, which could put pressure on profit margins or slow the pace of disinflation.

The Federal Reserve will release June data on industrial production and capacity utilization. Production was weak last month, much as in last month’s retail sales data. Once again, we will be watching to see if the recent slowdown in production is the result of the unwinding of a jump in demand at the beginning of the year to get ahead of tariffs.

Thursday: The U.S. Census Bureau will release the latest numbers on retail sales for June before the opening bell. Last month’s report showed weak sales growth after a strong March, which likely reflected consumers buying ahead of expected tariffs. We will be watching to see if consumers are continuing to spend even as tariffs have mostly been put on hold.

Initial and continuing jobless claims will be out before the market opens. Continuing claims have been rising of late, and we’ll continue to monitor this report for signs of changes in the strength of the employment picture.

The Homebuilders Index from the National Association of Home Builders will be out in the morning. Confidence among builders remained subdued last month due to concerns about tariffs, building costs and interest rates.

Friday: The University of Michigan will release its preliminary report on July consumer sentiment and inflation expectations. Consumer sentiment has tumbled in recent months as inflation expectations have turned higher in response to concerns about tariffs. We will be watching to see if the trend continues or if there are signs that those concerns are having an effect on attitudes toward purchases in the months ahead.

We’ll get June housing starts and building permits from the U.S. Census Bureau. This data, along with the Homebuilders Index released on Thursday, will provide insight into the home construction market.

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