US Government Hiring Frozen, But it is Europe that must Let it Go?

“You got me hypnotised” ? ??????? Def Leppard, Let It Go!

Written by Neil Staines, 24th January 2025.

In our last piece, we discussed i) The weakening macro picture in the UK and ii) our expectations for the Presidential inauguration. In the UK we argued that “our view remains that the UK economy is weaker than the high-frequency data suggest, and that downside risks remain. Against that backdrop we would expect the Bank of England to cut rates faster (perhaps significantly faster, as hinted at by MPC member Alan Taylor, of 125-150bps in a benign inflation case) than the moderate pace of rate cuts priced into the current strip - 62bps through 2025”. While Chancellor Reeves stuck to the upbeat message that the government's measures will generate growth further out the projection period and, thus, the fiscal rules are not in jeopardy whilst on her marketing trip to Davos. Back home, Sainsbury’s (one of the dominant UK supermarket chains) announced that it would cut more than three thousand staff as a direct function of the tax-raising measures of the October Budget.?

Furthermore, this week's UK employment report highlighted rising unemployment and falling vacancies - not the ideal combination. The economic path for the UK is undoubtedly complicated. For us, the medium-term finances of the UK (at least in relation to the Labour government's self-imposed fiscal rules) a concern. In the near term, we would have more confidence that the path of interest rate cuts will be faster than currently priced as the fiscal expansion (that will feel like a tightening at the consumer level) at the October Budget plays out by reducing employment growth and ultimately lowering inflation by reducing demand. It is possible this improves the growth trajectory in the out years of the fiscal forecasts, but it is a big risk.

Inauguration

This week (as we outlined last week - Village People vs. Davos People) witnessed the Presidential Inauguration in the US, set against the gathering of the global elite at the World Economic Forum in Davos. As many of the panels centred around the theoretical discussions of remedies to the ‘Industrial’ or even ‘existential’ crisis faced by Europe at the current juncture, what was eminently clear was that one big difference between the two economic zones was that the US under Trump is moving at pace, while Europe engages in a long theoretical debate about European economic philosophies. While there was much acknowledgement (and explicit criticism from Trump in his Davos address) about the restrictive nature of red tape and overregulation in Europe, there is no sign of a solution.?

Tariffs

In the US, it is impossible not to discuss tariffs. Or, more importantly, tariff expectations. Last week, we argued that US rate cut expectations had ebbed too far in the hawkish direction - much of that based upon expectations of fiscal expansion fuelled inflation and growth resurgence - but the biggest impact this week has been the under-delivery of tariffs from Trump relative to expectations. Last week, we argued that the ultimate Trump policy delivery may not be aligned to consensus expectations - We saw, and continue to see tariffs as more of a negotiating tool than a long-lasting policy tool.

At his confirmation hearing, Treasury Secretary Bessent outlined the three ways in which tariffs can be used (i) to counter unfair trade practices (state subsidies for example), (ii) as a revenue raiser (to use US domestic demand to more optimally assist with the Federal Budget) and (iii) to negotiate desired economic or social benefits - indeed, Bessent highlighted that this tool, as an alternative to sanctions could prevent further deterioration in use of the USD. This week, Trump’s rhetoric has been consistent with a preference for (iii). Importantly, Trump has also commissioned a report into global trade practices and the impact on the US trade and current account deficits with a deadline of April 1st - Perhaps we will see some April Fools tariffs, but in the meantime, we are biased toward a more collaborative approach - obviously with the threat of tariffs hanging over that corroboration!?

Let it Go?

Another Trump policy that has not got much airtime over the course of the week has been the Presidential Action to freeze all Federal civilian hiring for the next 90 days whereby a number of government agencies, including DOGE will submit a plan to reduce the size of the Federal Government’s workforce through efficiency improvements. Over the last year, Government hiring has accounted for around 40,000 jobs per month - for the next three months, that number will thus be close to zero.

We have argued many times of late that the overwhelming majority of analysts (including the FOMC projections) see little to no upside risk to the unemployment rate through the forecast horizon (to 2027). Manufacturing jobs should ultimately be supported by Trump's inward investment initiatives, but the immediate picture is perhaps more negatively skewed for the labour markets.?

Inflation

Following on from last week’s downside surprise to both CPI and PPI in the US, we are inclined to see a more benign trajectory for US inflation through H1 - certainly relative to the market forecasts that include a significant Trump inflation premium. Indeed, the current 3m and 6m Core PCE are on an annualised basis and are already close to target (2.2% and 2.3% respectively). Furthermore, while there is likely a tick up in the month-on-month rate for the January inflation data (January effect) it is likely to be smaller than the January effect in Jan 2024, when auto insurance and other factors unlikely to be repeated were the dominant drivers. Cleveland Fed Inflation Nowcast suggests Core PCE will drop to 2.55% y/y in January, from 2.83% in December

The Fed SEP projection for 2025 was upgraded at the December meeting to 2.5% from 2.2% in September, partly due to the higher-than-expected growth and inflation prints through Q4, but also as a function of expected Trump tariff inflation uncertainty (Trump premium). From a policy perspective, if we are correct and there has been significant ‘front loading in trade ahead of potential tariffs and growth does not pick up sharply due to Trump's economic policy, then the data payback could well make rates in the US look very restrictive - especially with downside risks to the inflation trajectory.

The Long & Short of it…?

Next week, the emphasis and market focus may shift back towards Europe as the ECB meeting brings focus on the Eurozone economic and inflation trajectory. The discussion now likely shifts towards the split of the Governing Council on the likely need for the policy setting to go below neutral … “wherever that is” (as BuBa President Nagel said this week). Markets also await the outcome of the German election and the prospect of some fiscal easing from Germany. However, the real game changer for Europe will likely come in the form of ‘letting go’ of their ever-tighter regulations.

In the US, risks and uncertainties still clearly remain on all fronts. However, we continue to see risks as more two-way than the market consensus suggests, and while Europe talks, it is clear that Trump will act.

What is happening next week?

For professional investors only

This newsletter is issued by Eurizon SLJ Capital Limited (“ESLJ”), a private limited company registered in England (company number: 09775525), having its registered office at 90 Queen Street, London EC4N 1SA, United Kingdom. ESLJ is authorised and regulated by the Financial Conduct Authority (FRN: 736926).

This newsletter is a marketing communication intended solely for professional investors in jurisdictions where the public offering of products or services is authorized and is provided only for information purposes.

It has not been prepared in accordance with legal and regulatory requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. It does not constitute research on investment matters and should not be construed as containing any recommendation, advice or suggestion, implicit or explicit, with respect to any investment strategy or financial instruments, the issuers of any financial instruments, or a solicitation, offer or financial promotion relating to any securities or investments.

ESLJ and its affiliates do not assume any liability whatsoever for the contents of this newsletter and do not make any representation or warranty as to the accuracy or completeness of any information contained in this communication.

Views are accurate as of the time of publication. Opinions expressed by individuals are their own and do not necessarily reflect those of ESLJ or any of its affiliates.

The value of any investment may change, and an investor may not get back the original amount invested. Past performance is not an indicator of future performance.

This communication may not be reproduced, redistributed or copied in whole or in part for any purpose. It may not be distributed in any jurisdiction where its distribution may be restricted by law, and persons into whose possession this communication comes should inform themselves about, and observe, any such restrictions.

ESLJ is a company of Intesa Sanpaolo SpA.