Inflation Fears Trigger Market Uncertainty

The latest economic numbers weren't exactly a cause for celebration. In fact, they landed with a thud, signaling potential turbulence ahead. If you're not paying close attention to these shifts, you're essentially trying to navigate a minefield in the dark.

Insights

• Recent economic data, particularly in the services sector PMI, indicates a significant slowdown and potential contraction, raising concerns about broader economic health.
• Inflation expectations, while headline CPI has moderated to 2.4% as of March 2025, show underlying persistence in certain measures, keeping businesses and policymakers on edge.
• Uncertainty surrounding government policy, including tariffs and spending adjustments, is reportedly dampening business confidence and investment.
• Businesses may face a margin squeeze, absorbing rising input costs due to an inability to pass them fully to consumers in a competitive environment, potentially leading to cost-cutting measures.
• Strategic positioning, including maintaining adequate cash reserves and focusing on fundamental value, becomes critical in a shifting economic environment.

Economic Signals Flash Yellow: PMI and Inflation Concerns

Some economic releases are just noise; others are signal flares. Recent data falls squarely into the latter category, particularly concerning the Purchasing Managers' Index (PMI) and inflation sentiment.

Initial forecasts suggested that the S&P manufacturing and services data could cause ripples if they strayed far from expectations. "Strayed far" turned out to be an understatement for some components. Compounding this, the University of Michigan sentiment survey, while not always a market mover unless drastic, delivered a jolt.

While the Consumer Price Index (CPI) for the 12 months ending March 2025 showed a decrease to 2.4%, down from 2.8% in February, and core inflation similarly moderated to 2.8%, underlying inflation expectations present a more complex picture.

The University of Michigan survey for May 2025 indicated year-ahead inflation expectations at 3.1% and five-year expectations at 2.9%. These figures, while not the "30-year highs" seen in some past reports, still point to a persistent stickiness that the Federal Reserve cannot ignore. Recent price trends have certainly been elevated, and these expectations suggest the battle isn't quite won.

Some of this unease might stem from discussions around potential tariffs. It doesn't necessarily mean a dramatic resurgence in across-the-board consumer price hikes is imminent – prices have already stretched household budgets considerably.

But it’s a development worth watching. The PMI data, however, paints a more immediate and arguably more concerning picture of economic momentum.

The Political Cycle and Economic Realities

There's a familiar pattern in markets, one that often plays out around political transitions. A surge of optimism, a kind of "hope premium," can inflate asset prices as markets anticipate new policies or a change in leadership.

The challenge? Peak enthusiasm often coincides with the moment a new administration, or the prospect of one, solidifies. Reality then has a tendency to assert itself. The market begins to digest the complexities and potential downsides of proposed changes.

Questions about tariffs, the actual economic impact of initiatives like widespread government efficiency drives (sometimes dubbed "Doge"), and geopolitical stability move to the forefront.

From a purely financial standpoint, businesses and investors begin to adjust their strategies. Uncertainty about tariff structures or the ripple effects of reduced government contract spending – many of which are private sector engagements contributing to Gross Domestic Product (GDP) – leads to caution. Geopolitical tensions add another layer of complexity.

This isn't about political leanings; it's about recognizing an economic rhythm. An initial wave of positive sentiment can be followed by a leveling-off, and then a gradual erosion of that enthusiasm as the practicalities of governance and policy implementation become clear.

Promises of significant fiscal changes, like tax cuts, often take longer to materialize than initially hoped, with their economic effects delayed even further.

This brings us to the recent S&P Global Flash PMI report. The details within are sobering.

The PMI Plunge: A Deeper Look at Services and Margins

The S&P Global Flash US Services PMI for May 2025, for instance, registered 50.9. While this indicates a slight rebound back into expansion territory (a reading above 50 signals expansion), it followed a period of significant weakness, such as a prior reading of 49.7 which marked the first contraction in 25 months.

Even with a headline improvement, underlying components like new orders and business expectations can reveal lingering fragility.

The cause for such downturns often traces back to sharply weaker new order growth and a slump in business expectations for the year ahead. A common thread in business commentary is the growing concern and uncertainty related to federal government policy – a broad term encompassing potential tariffs, spending adjustments, geopolitical risks, and tax policy ambiguity.

Interestingly, reports have sometimes noted that upturns in manufacturing output were linked to businesses front-running anticipated tariffs. This suggests a temporary, rather than sustainable, boost. This aligns with observations that some of the economic buoyancy seen previously could have been an inventory build-up, an enthusiasm-driven bubble.

Businesses stock up, anticipating strong future demand. If that demand doesn't materialize as expected, they're left with excess inventory and unfulfilled pre-orders. That’s when discussions about workforce adjustments typically begin.

"The stock market is filled with individuals who know the price of everything, but the value of nothing."

Philip Fisher Investment Analyst and Author

The question of tariffs and inflation is a common one. Yes, tariffs can increase cost inflation for businesses. The critical point, however, is whether businesses can pass these higher costs on to consumers. Many analysts believe businesses will increasingly have to absorb these costs within their profit margins. It’s not a preferred outcome, but intense competition may leave them little choice.

When businesses absorb costs in their margins, their earnings per share (EPS) can suffer. The subsequent move is often cost-cutting, which can include layoffs. Simply increasing prices for consumers becomes difficult if competition is stiff and supply chains are relatively unconstrained.

Indeed, economic reports have highlighted input cost pressures spiking, especially in manufacturing, as suppliers pass on tariff-related price increases and wage pressures continue. Yet, intensifying competition has often limited the pass-through to consumer selling prices, particularly in the service sector, where price inflation has, at times, fallen to multi-year lows.

This isn't necessarily a shock to seasoned market watchers, but the speed and intensity of these shifts can be unnerving. Charts tracking future expectations in flash PMI surveys often show a sharp decline after periods of peak enthusiasm, effectively erasing earlier gains in sentiment.

Weakness has often been concentrated in the services economy. Output has seen contractions, and new business inflows into the services sector have, at times, nearly stagnated. This represents a significant worsening of demand growth compared to prior periods. While manufacturing might hold up intermittently, perhaps due to factors like tariff front-running, the broader composite indices, heavily influenced by services, can show a more troubling trend.

Service providers frequently link these downturns to political and policy uncertainty – concerns over federal government spending, potential impacts of new policies on growth, and inflation.

The optimistic mood from earlier periods can evaporate quickly, with outlooks becoming notably gloomier than they were post-pandemic. Sales are reportedly hit by this uncertainty, and while supplier prices rise due to tariffs, companies, as discussed, often absorb these costs.

Raising consumer prices is a tougher proposition now, especially for non-essential goods, given that supply chains have largely normalized and competition is robust. Your grocery bill might still feel painfully high, but we're discussing broader economic categories here.

The Specter of Deflation and Policy Responses

It's plausible that many businesses will actually face deflationary pressures in terms of what they can charge consumers. Consider a hypothetical new tech product, say the "Echo" smartphone, offering 98% of a premium model's features for 75% of the price.

That’s a form of deflation for the consumer. We are likely to see more of this: pressure on vehicle prices, phone prices, computer prices, and furniture prices. This trend could accelerate, especially if businesses begin significant layoffs due to margin compression.

The employment picture is also a critical indicator. Reports have noted shifts in employment trends, sometimes showing declines after periods of strong job growth. Major companies, even those with histories of avoiding layoffs, have announced workforce reductions, signaling broader cost-cutting pressures.

Southwest Airlines, for example, conducted significant layoffs, a rare event in its history, impacting around 1,700 employees. These aren't isolated incidents; they are signals of a changing economic climate.

"Do not save what is left after spending, but spend what is left after saving."

Warren Buffett CEO of Berkshire Hathaway

What might reverse such negative trends? Economic analysis suggests a need for clarity on tax policy and a solidification of tariff structures. The potential economic drag from large-scale government spending cuts would need to be offset by measures that stimulate economic activity.

This is why discussions around "Doge stimulus checks" or similar initiatives sometimes surface. If government spending is drastically cut, it's a nod to fiscal discipline. But if those cuts aren't counterbalanced by redirecting funds back into the economy, it removes stimulus, acting as an economic brake.

Does cutting government spending save money? Yes, for the government's balance sheet. But consider what happens when an individual saves money and doesn't spend or invest it.

The velocity of money – how frequently a dollar changes hands in the economy – slows. That saved, inactive dollar isn't contributing much to GDP. When the government curtails spending and that money effectively "stops" circulating, it can create a similar drag on economic activity.

This is an economic principle, not a political stance. Spending cuts can be offset by targeted stimulus. Such stimulus wouldn't necessarily be inflationary if directed towards sectors where supply chains are loose, which is largely the case in the post-COVID environment for many goods.

A significant concern for many market observers is that if supply chains are very loose, the economy could risk a deflationary spiral, particularly if layoffs pick up pace.

If significant layoffs materialize, the Federal Reserve's stance could shift. As of May 2025, the Fed is maintaining steady rates, emphasizing a data-dependent approach. Markets are pricing in potential rate cuts later in the year should economic weakness become more pronounced, but "fast cuts" are not the current base case.

Rate cuts, when they happen, could make real estate borrowing cheaper. More people might technically qualify for a mortgage, but job losses would mean fewer are in a position to buy.

This could create a scenario where those with available capital acquire assets at more favorable financing terms. It's a challenging situation for individuals caught between job insecurity and fluctuating interest rates – a matter of unfortunate timing rather than anyone's specific "fault."

Analysis

The confluence of these factors – weakening PMI data, persistent if moderated inflation concerns, policy uncertainty, and potential margin squeezes – paints a complex picture.

It's not a simple narrative of impending doom, nor is it a clear path to renewed robust growth. Instead, it suggests an economy at an inflection point, where vulnerabilities are becoming more apparent.

The "hope phase" often associated with political or economic turning points appears to be giving way to a more sober assessment of challenges. Businesses are not just reacting to current conditions but are also trying to anticipate future policy impacts, which creates a feedback loop of caution.

The front-running of tariffs, for example, might offer a temporary boost to manufacturing but masks underlying demand issues and could lead to an inventory overhang if final demand falters.

The pressure on profit margins is a critical element. If companies cannot pass on rising input costs (from tariffs, wages, or other sources) to consumers due to intense competition or weakening demand, they will look to cut costs elsewhere.

Labor is often one of the largest variable costs, making layoffs a likely outcome if margin pressure becomes severe. This, in turn, can dampen consumer spending, further weakening economic activity.

The yield curve's behavior also merits attention. As of May 2025, the 10-year minus 2-year Treasury spread has turned slightly positive (e.g., +0.10%), after a prolonged period of inversion which historically has been a reliable recession indicator.

This steepening, while sometimes a sign of recovery, can also occur as the market anticipates Fed rate cuts in response to a slowing economy, or as recession risks become more tangible. JPMorgan and other institutions continue to note the yield curve’s historical predictive power, even if unique post-pandemic factors might alter traditional timelines or interpretations.

The low cash levels reported by institutions like Bank of America, while having risen slightly to around 4.0% for institutional investors by May 2025 from previous 15-year lows, still suggest that many market participants might be heavily invested.

If a sharp market downturn were to occur, the scramble to raise cash could exacerbate selling pressure. It's prudent to consider these signals thoughtfully rather than dismissing them as mere fear-mongering. These are data points that warrant careful strategic consideration.

We may also be observing longer-term market cycles. Historical charts of indices like the S&P 500 show periods where new all-time highs are elusive for extended durations. After the dot-com bubble, it took roughly a decade for the market to forge new sustained highs. The 1970s inflationary period saw about six years of stagnation in terms of new peaks.

Following the Great Depression, it was over two decades. While "flat" doesn't necessarily mean a crash, it can involve periods of declining prices or simply a prolonged absence of new, sustainable highs. Some analysts express concern that we might be nearing the end of the current long-term bull market, potentially facing such a plateau.

Final Thoughts

So, what does this all mean for your financial strategy? This isn't a call to panic. It's a call for clear-eyed preparation and an understanding of the evolving economic terrain.

The surge in long-term inflation expectations seen in some past surveys, while headline CPI has cooled to 2.4% as of March 2025, still reflects an undercurrent of price pressure that keeps the Federal Reserve vigilant. The University of Michigan's May 2025 survey showing year-ahead expectations at 3.1% and five-year at 2.9% underscores this.

Furthermore, significant weakness in data like the S&P Global Flash Services PMI (which recently showed contraction before a slight rebound) is a major indicator. This is a crucial development, especially since the services sector has been a key driver of post-pandemic growth.

Vigilant observation of these trends is paramount. Consider these strategic approaches:

• Building Cash Reserves: Cash, or liquid assets, might not offer spectacular returns, especially with current interest rates providing modest yields on cash holdings as of May 2025. However, its value in providing flexibility and opportunity in a volatile market is immense. With general cash allocations having been low, possessing "dry powder" when others might be forced sellers can offer a distinct advantage.
• Focusing on Real Value: This environment may not favor chasing speculative assets. Instead, identifying fundamentally sound investments and opportunities that can withstand economic headwinds, or even benefit from a changed economic landscape, is key.
• Skill Enhancement: In an economy where businesses are carefully managing margins and potentially considering workforce adjustments, personal and professional skills become even more valuable. What unique value do you offer that is difficult to replace or automate?
• Long-Term Perspective: For investments in assets like real estate or equities, thinking in terms of decades, not just months, is crucial. Short-term market volatility can be unsettling, but a long-term view often helps to smooth out these fluctuations and focus on underlying growth potential.

The economic conditions are clearly shifting. The period of exceptionally easy money, characterized by massive stimulus and near-zero interest rates, appears to be behind us for the foreseeable future. We are entering a phase where astute, strategic thinking and emotional discipline will be your most valuable assets.

Don't be caught unprepared. The warning signals are present. It's time to be watchful, strategically positioned, and ready to act when genuine opportunities emerge from any market dislocations.

The winners in this next economic chapter will likely not be those who succumbed to panic, nor those who ignored the changing conditions. They will be the individuals who understood the terrain and navigated it with foresight and skill.

Stay informed, think rationally, and be prepared. Change is a constant, but with change comes opportunity for those who are ready to adapt and act decisively.

Did You Know?

The term "bear market," referring to a period of declining stock prices, is thought to originate from the way a bear attacks, by swiping its paws downwards. Conversely, a "bull market" (rising prices) is likened to a bull thrusting its horns upwards.

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Disclaimer: The information provided in this article is for general informational purposes only and does not constitute financial, investment, tax, or legal advice. It is essential to consult with a qualified professional before making any financial decisions. The author and publisher are not responsible for any actions taken based on the content of this article. Market conditions are dynamic, and past performance is not indicative of future results.