It’s about tariffs.
Markets on Thursday had another wild swing, falling as much as 3% before recovering most of the day’s losses with tech stocks actually closing in positive figures. This volatility followed the nearly 800-point decline in the Dow and the more than 3% drop in the S&P 500 and Nasdaq on Tuesday.
And while all the major worries for investors — higher rates, slowing earnings growth, recession risks, and the trade war — remain in play, this week’s action should make clear that right now, markets and businesses are most sensitive to what’s happening with trade.
On Wednesday, the Fed released its latest Beige Book report, a collection of economic anecdotes from each of the Fed’s 12 districts that helps form the basis of the economic discussion that will take place at the Fed’s next policy meeting, set begin on December 18.
“Most Districts reported that firms remained positive,” the report said, “however, optimism has waned in some as contacts cited increased uncertainty from impacts of tariffs, rising interest rates, and labor market constraints… Reports of tariff-induced cost increases have spread more broadly from manufacturers and contractors to retailers and restaurants.”
Throughout the country, business leaders in a variety of industries cited tariffs as pressuring costs and tamping down their overall economic outlook. The report also suggests that tariffs and labor shortages are likely to be drivers of inflation in the months ahead, a dynamic that isn’t likely to prompt the Fed to back off its interest rate forecast.
And for any investors still not convinced that the biggest worry for markets right now is tariffs, the Beige Book should put any lingering skepticism to rest.
The Cleveland Fed noted that, “Contacts noted that tariffs were lifting prices further down the supply chain.” Out of the Richmond Fed, “Manufacturing and services firms saw a sharp in-crease in input prices, which were attributed to tariffs, shipping costs, and some higher business-to-business and recruitment costs.”
“Price pressures eased but remained elevated in part due to the tariffs, and outlooks were less optimistic than the previous report,” according to the Dallas Fed. And in the Philadelphia Fed’s district, “Tariffs remained a major concern for many producers.”
The Institute for Supply Management’s latest reading on activity in the services sector also showed concerns about tariffs, with an executives in the public administration sector saying, “The imposition of and threats to impose tariffs are having a negative effect on several capital-improvement projects in progress… The increases are not expected or budgeted for.”
An executive in the retail sector also told the ISM that their business, “is preparing for the later phases of tariffs by slowing down growth and capital investment until the future becomes clearer.”
On the labor front, commentary out of both the Beige Book and ISM report was similar to what this report has indicated for months — there are labor shortages everywhere and wages are slowly starting to respond.
“All firms noted labor supply shortages, regardless of the job’s industry, occupation, or placement type, while commenting on the high and healthy demand from clients,” according to the Boston Fed. “One company stated that they were hesitant to take on new clients because they could not fulfill orders from existing ones.”
In the Atlanta Fed’s district, “Contacts shared that driver shortages caused supply chain delays and negatively affected their ability to meet customers’ demands.” The answer for some of these businesses however, is to just wait. “Employers encountered some tightening for other positions and business areas,” the Atlanta Fed added, “however some contacts expressed a willingness to wait for the right person rather than pay more, since they do not believe that higher pay will guarantee a higher quality worker.”
The Kansas City Fed delivered more positive news for those economists that still believe in the Phillips Curve — a model that says lower unemployment rates result in higher wages — saying that in its district, “A majority of respondents continued to note labor shortages for low- and medium-skill workers, including positions for retail sales, commercial drivers, specialized IT, construction, and restaurant staff. Wages grew modestly since the previous survey, and most contacts reported higher starting wages for new hires. Wages were expected to increase at a similar pace moving forward.”
The ISM added succinctly, “Business is booming. Labor costs are rising.”
Last week, the S&P 500 had its biggest weekly gain in seven years. The week’s most exciting day came Wednesday, when the major indexes gained over 2% following a speech from Federal Reserve Chair Jerome Powell that investors interpreted as a softening of the Fed’s plans to raise interest rates up to three times next year.
The rally in markets also came ahead of last weekend’s G-20 meeting, which investors had seen as a time for the U.S. and China to ease the trade tensions which had been overhanging on markets for much of this year. The initial word out of a Saturday evening dinner between President Donald Trump and Chinese President Xi Jinping was that tensions had been de-escalated and that no new tariffs would be put in place during a 90-day negotiating period.
Investors came into this week excited. The messaging on what was actually agreed upon at the G-20 meeting, however, quickly became muddled, and reports by Tuesday indicated the entire truce could be falling apart.
Pair a tentative-at-best truce on trade with a labor market that doesn’t show signs of slowing down or easing wage pressures that will keep the Fed emboldened to continue raising rates until it believes it has found the neutral rate, and investors should expect even more days like Thursday.
Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland