The Policy Mosaic End Game

Detoxing the labor market, fiscal inflation, the Fed's blind spot, uneven earnings growth, another FOMC step towards neutral, the end of QT

In this week’s note:

• Three shocks, reduced government spending, immigration and tariffs, are contributing to a sharp deceleration in employment growth.

• The even larger negative contributor to weak employment is the Fed’s rate policy, another 75bp will ease policy to a neutral setting.

• With Fed easing, the stage is set for stronger growth in ‘26. A recovery in the labor market in early ‘26 is the crucial signpost to determine the efficacy of the Trump Administration’s policy mosaic.

• CPI missed expectations, while lag impaired rent of shelter was the largest drag, the more important factor is the sharp deceleration of government spending on non-housing services (super core) inflation.

• Super core CPI heated up from 3% to 5% amidst 11% government spending growth in fiscal year ‘24 (ended September) and returned to 3% during FY25 was government spending growth decelerated to 3% growth. This is not a coincidence.

• Earnings surprise is similar to the last few quarters and stocks are responding favorably, but the yearly estimate is not increasing much and margins for consumer companies are under pressure.

• The Fed is set to take another step towards neutral rate policy and end QT but curb your enthusiasm about the end of large-scale asset purchases because the Fed needs to lengthen the SOMA portfolio duration.

• Gold, bitcoin, and global capital account rebalancing

Figure 1: Cutting through all the noise, prices are stable as measured by the annual standard deviation of all items CPI. The median since 1947 is 58bp, it is currently 24bp. The correlation of the components is low, consistent with our thesis that the fiscal and monetary conditions that threw lighter fluid on the campfire in March ‘21, are not in place at present.