Monthly Macro with Richard de Chazal—February 2025

William Blair macro analyst Richard de Chazal reflects on February’s economic narratives, including the impact of noisy data, government spending cuts, climate change, mass deportations, recent inflation data, and the evolving nature of inflation on future monetary policy decisions.

Podcast Transcript

00:21
Chris T
Hi everybody. It's February 25th, 2025. Richard de Chazal is back alongside me for another episode of Monthly Macro. This time to look back at the February economic narratives that have popped up since our last recording. Richard, welcome. Let's jump right in.

First, by looking broadly at what's happening in the economy at the moment, it seems like there are more questions than answers across the board lately. But based on what you're seeing, any red flags? Are we starting to see an economic slowdown emerging? I would love your take.

00:51
Richard D
Yeah, sure. Maybe before talking about the economy, I think it may be worth talking about the data that we use to measure the economy. And I think what's kind of difficult, at the moment, as the data has been really noisy. I think what's funny is that you would think with the emergence of big data, and now AI, you'd think that the degree of granularity that we can get on the data or on the economy would just be improving month after month, year after year, you'd be able to get a better read. But it actually doesn't really seem to be happening. If anything, it is getting a little bit worse. And I think that is for a couple of reasons.

One is that the response rates that we're getting for a lot of the surveys that the government does or the private sector does have been falling in some cases by about 50%. And I think that's because people are maybe inundated with too many concerns about too much information being put out there on themselves. So they're reluctant to answer any more surveys that that might give away too much information. And I think another problem that that some of the government sectors have highlighted has been that you've had a lot of cuts in government spending over the last few years. So data collection has been more difficult if you don't have the funds to actually do that collection. And that's actually before DOGE and Trump. So this is this has been going on for a few years now.

The other thing is that, funnily enough, climate change is actually making things harder to in the sense that we've had what seems to be more and more instances of these one-off freaky weather events like flooding, or ice storms, or fires and that kind of messes around with the seasonal adjustment factors.

So when you actually try to strip out what are normal seasonal patterns and what's the actual underlying data, that's getting a little bit harder for the statisticians at some of these departments. And the Covid, of course, over the last few years that really screwed around with the data as well in the sense that what were sort of normal spending patterns kind of got flipped on its head in various forms during the Covid as consumers were not typically spending as they normally would. So as we've sort of been closer to those years, the seasonal adjustment factors put a greater weight on more recent years. So that again is skewing some of the data. I think that it's interesting.

I think one other factor, now that I think about it, and this is showing up quite significantly in some of the recent data, and it's kind of sad actually, is that what's also skewing it is how you actually perceive the economy in the sense that how you perceive the economy is increasingly being shaped by your political outlook. In the recent University of Michigan survey, that's a survey that actually breaks up responses from the respondents into how they're voting by political party. What we saw in the last one for February, was that aggregate sentiment about the economy dropped quite significantly. All of that weakness was respondents on the Democrat side, or people who identify as being Democrats, where their sentiment really dropped off a cliff.

But if you're a Republican, that confidence level has been improving. Things actually look better from their perspective. So I think that mattered less in the past when maybe politics was less divisive. But that seems to be having a bigger impact these days and may be suggesting that data is a little bit less reliable and I think that's also then skewing some of the politics we're seeing coming out of that because if you don't get the data that you want to see, you can start blaming it on flawed statisticians and flawed data collection and all that kind of thing. So that's not a good starting point and surprising where we are and how modern we feel the economy should be today.

The other thing though, I would say in terms of the actual economic data and what we've seen recently, I think we have seen the economy has been decelerating. Few cracks are starting to sort of show through here and there. Overall, I'd still say, like Powell likes to say, the economy's still in a pretty good place. And maybe one way to think about it too is at least maybe from financial markets, we always watch this thing so carefully but maybe your average Joe on Main Street isn't feeling so bad. But maybe one way to think about this is that where the economy has been disappointing, it's been disappointing relative to expectations. So if we look at the economic surprises indices, which measure the actual data relative to what was expected by economists, maybe expectations were too high. And we're now kind of coming out of this, post-election honeymoon period. The euphoria around the election is kind of starting to wear off. Reality is starting to set in and maybe we're starting to think those expectations were a little bit high. The data is not actually going to be quite as strong as what we were originally thinking.

A key problem is also there's just so much uncertainty with what's going on. I mean, Trump has been flooding the zone with the executive orders on tariffs, on deportations, on the DOGE. You know, our heads are just totally spinning. We're all trying to figure out how these things are going to change the economy, how significant they are.

On tariffs, we're trying to figure out what's happening there. I mean, so far, despite all the headlines, the only tariffs that are actually in place at the moment are an extra 10% tariffs on China. The steel and aluminum tariffs, they're going to be kicking in in the middle of March. Tariffs on Canada and Mexico, which splashed across the headlines, those have been pushed further back to now the fourth of April. I see that Mexico is now sending something like 3000 troops to the border for greater border security. So we'll see what happens there. And then I think the most important and most significant tariffs are these 25% reciprocal tariffs on basically all countries and even includes VAT as a measure of tariffs. Those are supposed to kick in on the first of April.

And then on the DOGE, that's clearly not very stimulative for the economy, certainly in the very near term. If it succeeds in cutting government spending, that then could get reflected in lower interest rates. That could actually be a positive. I think that in recent interviews with Treasury Secretary Scott Bessent and is something that he's really counting on.

9:06
Chris T
Yeah, that's ultimately - that's the goal, right?

9:08
Richard D
That's the goal. The goal is, it’s funny actually, and I think it's significant. If you remember in Trump's first term, his gauge was the stock market. And I think this time around Besson is saying the gauge for how successful we are on our policies is going to be the ten-year Treasury.

9:29
Chris T
Interesting. Yeah, I could see that.

9:30
Richard D
So that’s a notable shift. Maybe it says something about how defensive they’re going to be if there are any wobbles in the market or whatnot. I think just in terms of these job cuts that are being splashed across the headlines, firing tens of thousands of government workers. I think what's important there and again, for the economy too is it's not like you're closing some factory in Detroit where that could be devastated for the town and the local area but not necessarily for the aggregate economy as a whole.

This is the federal government where you're laying off workers who work nationwide across the country and I think that potentially has a bigger impact on consumer confidence and consumer spending. I think it's noteworthy that the federal government is actually the biggest employer in the U.S. The government, or the federal government, employs about 3 million workers, about 2.5 million if you exclude the post office. I mean, there's about 20 million or so in-state and local workers. The DOGE doesn't really have a mandate to go after them. And then you also have 10 million, roughly, consultants to the government who would presumably also be cut back by the DOGE. So there is a reasonably big pool of workers who could be impacted here.

And where are we looking for that impact to show up? I think if you look at the initial jobless claims, so I've been watching those pretty closely in the last few weeks, particularly in the Washington area. But I think one thing to note here too, you would expect a laid off worker to show up at their unemployment office and start claiming unemployment insurance or pokey or the dole, as we call it in Canada or in Britain, to actually receive those payments, in many states. So those are done at the state level. You can no longer be receiving severance payments from your previous employer. The government has basically said that they're going to continue to pay severance until October for a lot of these workers. So, again, there could be a delay in the economic data when we actually see this coming through.

So I think the point is that the near-term risks to growth are to the downside. And I think with Trump, we're kind of getting the negatives first in terms of tariffs, DOGE, and job cuts and the expectation is that those are going to bear fruit further down the road. And the positives in terms of deregulation, tax breaks, and companies reshoring and hiring a lot of people, those haven't really kicked in or aren't really showing up just yet.

And I think with so many changes being thrown at us through these executive orders and whatnot, companies are just kind of sitting back, trying to take it all in, and they're worried about where this thing is going. They want more clarity if they're going to make more investments. So some new orders data is coming through. I think that's kind of pulling forward demand to get ahead of tariffs. But on the whole, with everything a little bit chaotic still it feels at the moment, the mood is a little bit cautious.

13:19
Chris T
I know you've touched on the economic implications of mass deportations in several notes recently. And this I think is a good segue. Let's talk about that a bit. What's been going on in the past few weeks as it relates to these mass deportations? And has there been any impact to economic data yet as a result?

13:37
Richard D
Yeah, I mean, good question. This this is going to be a huge issue potentially for the economy. And even if you're pro-Trump or anti-Trump, I think the situation is you've got about an estimated say 11 million illegal or undocumented workers in the U.S. right now. Trump has variously talked about deporting anywhere from eight to 11 or 20 million people. If we look back at past presidents and see who deported a lot, Obama was actually dubbed the “Deporter in Chief.”

14:19
Chris T
Which is interesting. I didn't realize that until recently.

14:21
Richard D
Yeah, he deported about 3.3 million. But the key is, that was over eight years, not over Trump's four-year term. Whether they're illegal or not, most of them are working. They're consuming, buying clothes, food, living at home or taking transportation. So even if you were actually successful in deporting a good chunk of those, I mean, that would have a very significant impact on the economy. It would be very stagflationary.

The most impacted area is clearly construction. So, if you look at that industry, about 28% estimated of that workforce consists of illegal workers, but then you move on down to agriculture and farming. So farms can't harvest their crops or milk their cows. That's going to raise food prices, healthcare and education, restaurants and hotels, these are all pretty big industries for this kind of labor.

And I think what's significant, too, is that we're at a time when the labor market is pretty tight. And even with all these extra immigrants coming in, and you have actually had a huge surge in the last three or four years, companies have still been complaining about labor shortages. If you look at the data and the BLS, Bureau of Labor Statistics, they break it up nicely into native-born workers and foreign-born workers.

And you can see that pretty much all of the growth from the last few years in employment has been for foreign-born workers. But I think what's interesting is that's not necessarily because companies are choosing foreign-born over native-born workers. If you actually look at the participation rates, the participation rates for native-born workers is really high.

So, these foreign-born workers are sort of satisfying that excess demand for labor that the economy hasn't been able to provide through native-born workers. So, it's not like these foreign born workers are pushing out the native workers. And when Obama was doing all the deportations, that wouldn't have necessarily been the case because there was a lot of excess supply in the labor force because this was the post GFC period. So, I think that's a crucial difference, which means the impact of deportations this time around could be much more significant.

So, what's actually happening? Fortunately, getting back to the data, it feels a little bit like the Covid situation again, where there seems to be a lot of things happening on the ground, but it takes time for the data to actually show that. So we’re not actually seeing that in the data per se. The Department of Homeland Security, for a while, from the inauguration into the first week or so of February, they were actually publishing daily arrest rates, which would kind of give you a gauge of how many people were potentially being deported.

They stopped publishing that for some reason. We don't know. I think if you read some reports, there was a lot of inaccuracies in the reporting of that data. But what it definitely heard is a lot of anecdotal evidence when talking to people of what they've been noticing. So driving into work they might see that parking lots and breakfast cafes where a lot of say, these migrant workers would be in the morning, those are now much less busy parking lots, more empty roads, less congested busses and metros, less busy as well. If those commuters are not necessarily commuting into work and even someone was telling me they're talking to a doctor, and doctors are seeing a lot more missed appointments. So no shows. Maybe because health insurance has expired or they're afraid to leave their homes. And I think that's one of the problems is that these deportations have been so well publicized that there's quite a significant fear out there that people don't want to leave their homes. They're not showing up to work because they're worried about the ICE squads potentially deporting them.

And if that's actually the case we could see this starting to show up in the economic data through areas like gasoline consumption. So if you're driving less to work you're consuming less gas. We could see that in fewer hours worked. So particularly in those industries like construction, where a lot of those workers work. I'm looking at remittances data, particularly to Mexico. So the Bank of Mexico publishes how much money is being sent back from Mexican workers to their home, Mexico. So you can see those flows. And actually, we haven't got it yet, but we could start to see it in the monthly nonfarm payroll and household survey data of employment.

So there is this feeling that they're under the table workers and they don't show up in the employment data, but they actually do in the sense that a lot of companies do record them on their books. They pay taxes on them. And that's because a lot of workers, when they're hired, they might show documentation, they might show a driver's license or work permits, but it's not incumbent on the employer to actually verify those documents. So they could be expired, they could borrow someone else's documentation, and the employer doesn't go and check them. But, if he's ever caught out by that, they can say, well, we saw the documentation and we are counting them as is employed. We're clearly not hiding them under the table. So the point again is that if those workers are not showing up or because they're afraid or if they're actually deported, that should show up as well. At least a portion of those should show up as weaker employer data. But I think, at the moment, we're not seeing hard data yet. We're not seeing hard data in gasoline consumption. We're not seeing data in remittances coming down or in those hours worked, but we're watching those quite closely.

21:28
Chris T
In the past month, we've seen inflation data coming in a bit hotter than expected and then the U.S. Business Activity Index fell to a 17-month low. What does this mean for future monetary policy decisions? I mean, is this something we should be concerned about?

21:43
Richard D
One thing we have to recognize is the nature of inflation and what drives it has changed in the last few years since the Covid. So I think there's been a regime change in inflation. And this is something that we have to recognize in financial markets and monetary policy makers have to recognize as well because this is hugely important.

And I think what we've seen in the last couple of decades was inflation, or the inflation regime, was really a demand-side driven regime. And I think what that means is that it was really driven by a couple of things happening. One, on the labor side, we had a supply glut of labor, right? There was no shortage of workers, the boomers were in there, echo boomers were starting to work. You had globalization. You had a lot of outsourced workers. The problem wasn't a shortage of labor and if there was a bit of shortage, the labor unions were also crushed. So compensation side wasn't a problem. And then on the capital side, that wasn't so much a problem either, because you had globalization, you had outsourcing, capital was being set up in foreign economies. This was a servant driven economy. It was also a capital light economy, where it was mostly software, not hardware. You had $100 billion companies with just a handful of employees. So supply wasn't the main issue. It was more demand and the risk there was going to be not so much that demand was going to be too hot to fill in that there wasn't capacity. It was that only really that demand was going to potentially be too low, which meant that the risks on the inflation side were tilted to the downside. And if you remember, that's when Ben Bernanke came out with his famous “helicopter paper” back in 2002 talking about deflation and how to prevent it from happening here.

So I think what's changed since the Covid, is the economy is now turning capital heavy again and Trump is helping here. So the labor seems to be increasingly in short supply because of demographics, retiring boomers, slower birth rates, because of deglobalization and potentially deportations. And on top of that, companies increasingly need to invest more in heavier capital, physical capital, because of reshoring, that deglobalization, supply chains may be less reliable so you want to have more domestic production, tariffs maybe kicking in a bit there too. So the nature of the CapEx cycle seems to be changing and I think our tech analysts have talked about this. And again, moving from capital light, to software, to maybe more hardware, maybe more data centers, maybe more energy efficient facilities you need to spend money on.

And even actually we're seeing some of the big tech companies investing in energy facilities themselves, like buying these SMRs, or small modular reactors. So I think what that means for inflation is the dominant driver now flips from the demand side to the supply side and that any little shocks to that supply side from tariffs, from weather, from strikes, from port blockages, any sort of supply chain issues have the potential to ignite a surge in inflation more so than was previously the case.

So what does that mean for the central bankers for their response function is that the base level of inflation is now higher, call it 2.5%. The risks to the upside are now more evenly biased or maybe even tilting to the upside. Inflation is no longer a high-class problem as Minneapolis Fed Neel Kashkari once called it. And we're in a period where inflationary expectations coming out of the Covid are a lot more fragile. So I think what it means for the fed is they're going to be less quick to respond to any downside movements in the economy. And I think we could potentially be moving back into a Greenspan, opportunistic disinflation model where Greenspan would kind of drag its heels any time there was a bit of a disinflationary shock that would drive down inflation, maybe they wouldn't lower rates quite as quickly as they did previously.

And I think that's kind of what the Fed is sort of moving into now. They're less preemptive, more reactive. And it means the data and data-like measures that we haven't maybe paid too much attention to in the last few years, things like output gaps, productivity, wage rates, and energy are once again becoming more important than they were. And I think that's a really significant shift we need to think about.

27:44
Chris T
That’s interesting. Let's close this out. Before we do, let's touch briefly on earnings season, which, you know, this is arguably the longest earnings season in the four quarters. But what were some of the key takeaways this period? It's almost done. It's getting there.

27:58
Richard D
Yeah, we're pretty much done. I think we have like 470 odd companies in the S&P 500 having reported. I think for the fourth quarter was it was pretty good. Growth looks to have increased. I think the latest count was something like 13.7%, which is about double the 7.3% expectations you had going into it.

I think if you look at the trend performance for those earnings, it seems to have been far better than the average performance for the fourth quarter over previous years. So that's pretty encouraging. I think what was interesting though, is that if you look at the companies that beat, and then how much they're priced or what the price reaction was to that beat, there was literally no reward by the market. So the excess return for the S&P 500 was actually -0.3%. Whereas if you missed on earnings, you were getting dinged about 6.7% in excess of whatever the S&P 500 was returning. So it suggests that as we went into the quarter, a lot of the good news was priced in and less of the bad news. So I think for earnings growth this quarter, just looking at where it's tracking, seems to be progressing a little bit less than the average of the last 20 years.

So maybe slightly weaker, but you know, nothing too worrying and as a whole for the year a little bit lighter. But I think maybe getting back to what we were talking about earlier is if we are starting to see a resetting of expectations about growth in the real economy moving slightly lower, even though the data isn't the real economy, data isn't deteriorating that much, it's that resetting of expectations. You could also start to see that resetting of expectations for earnings as well. So that does raise a bit of a cautionary flag for the stock market going forward if that does start to unravel.

30:16
Chris T
Okay, Richard. That’s all the time we have for today. Always a blast chatting with you. I'm sure next month will creep up very quickly. Thanks for taking the time to be with us and everyone else, have a great month.

30:29
Richard D
Great. Thanks, Chris.