Making Sense of a Confusing Financial World

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The last several weeks have made what was already a jittery population more concerned than before with seemingly new headlines causing people to be nervous about both their present financial condition and their future. There are often differences in the direction policy makers go in the wake of an election, but the types of changes and the speed of them has led to an environment where many are feeling extremely uncertain about what to expect in the economic future of the U.S. and whether it can maintain its position as the world leader. One of the most prominent issues that is creating financial challenges both in the U.S. and around the world is the status of trade, which is being affected by the tariff policy proposed by the current presidential administration. That policy is having ripple effects throughout the world of finance as individuals and world leaders attempt to figure out where it will all go. After several days of bad news in the financial markets, a 90-day pause on most of the planned reciprocal tariffs was announced, perhaps giving us a short window to digest what is going on and determine how to move forward. Another issue causing concern and market disruption has been the president’s discussing the idea of firing the Chairman of the Federal Reserve (the Fed), Jerome Powell. None of us has a crystal ball to tell with any certainty what will ultimately happen, but in this month’s issue of the newsletter, we want to answer some questions that may help you understand some of the key issues at play and how you can prepare yourself for what may result from the direction the economy may be going.

What is the Real-World Impact of Tariffs?
You have undoubtedly heard a lot about tariffs in recent weeks and months, but tariffs are nothing new. Historically they have been used as a tool to strategically impact trade policy. The key word here is strategic, meaning that they have typically been used in situations where there was a specific objective, and they were implemented in a targeted way, unlike what we’ve seen in this version of tariff policy, which has been applied in blanket form. As has been widely discussed, tariffs in essence are a tax on imports, generally meant to discourage the importer from desiring to sell their product to the importing country. In isolation, that may sound like it serves the importing country well in terms of allowing it to make and sell that product to its own constituents, keeping the money “in house”. In the real world of today, very few products can feasibly be made with everything being done “in house”, so if product providers want to continue selling their products using the suppliers they have come to rely on, higher tariffs cause their process to become more expensive. If that is the case, they have a couple of choices. They can either take the hit and absorb the higher cost of inputs, or they can pay the higher cost to make the product but pass that cost on to the end consumer. In a competitive environment where profit margins are already squeezed for many manufacturers, it is more likely than not that they will simply pass the cost on to the customer, which in the end makes products more expensive. In a world where almost everyone is paying attention to the price of things and rapid inflation was a source of pain in recent years, seeing a big rise in prices after it looked like inflation was starting to stabilize is definitely cause for concern. Whatever the rationale is for the policy being discussed, the consequences are certainly being priced in by the financial markets, and they seem to be understood by individuals as well. The stock market, which is influenced by many factors and should always be looked at in context (see our March newsletter article), has taken a hit since the announcement of the proposed tariff policy, and the question is what other shoe may drop next.

Why Does Interest Rate Policy Matter?
The discussion around the potential firing of the Fed Chair most likely was a reaction to the way the market has responded to the rollout of the tariff policy and the Fed stating that the expected impacts of the policy made the situation such that a reduction in interest rates in the near term was less likely. For context, the Fed has two primary goals they attempt to balance: keeping inflation under control and maintaining strong employment. The biggest tool they have at their disposal to manage these competing interests is setting interest rate policy. Generally speaking, if the Fed wants to reduce inflation, like they did from 2023 into 2024, they will raise interest rates in order to slow down economic growth. On the other hand, if the Fed is seeking to improve employment, they will tend to lower interest rates to spur economic growth, with the intended result of having businesses hire more people. The Fed sets targets for the Fed Funds Rate, which is the rate at which banks lend to each other. While the Fed Funds Rate does not dictate broader interest rates, the direction of movement of that rate tends to filter into how other interest rates move. Therefore, when the Fed is lowering rates, under the assumption that interest rates in general will also lower, it makes the borrowing environment more affordable, enabling consumers to take out loans, which stimulates the economy and allows businesses better opportunities to make investments to expand. Prior to the start of this presidential administration, the Fed had been on a path of lowering interest rates because they felt comfortable that inflation was trending towards their target. However, with the potential for increased inflation from the implementation of tariff policy, further lowering interest rates could create even higher inflation. On top of that, the tariff policy, if implemented in its proposed form, could put businesses in a position to decide whether they can afford to keep their staff in place, so the potential for increased unemployment is real also. The combination of those factors and the uncertainty about what will actually be implemented regarding the tariff policy make it difficult for the Fed to know whether making a change to interest rates will yield a desired result.

How Can You Prepare if a Recession Comes?
Just because the stock market has been on a rollercoaster ride since early April, that does not tell us what will happen economically in the future. What the market turbulence does indicate is that there is sentiment that the economic future of the country is in question. Outside of the policy proposals that have driven the conversation in recent weeks, from most metrics, the economy has looked to be in good shape. If the most drastic tariff scenarios play out, prices rise and stay high, and interest rates remain at their current level, which is higher than what we have been accustomed to, a recession could result. The definition of a recession is two consecutive quarters of decreased economic activity, and when there is reduced economic activity, there is a higher likelihood of job losses. Because the majority of our economic growth is driven by consumer spending, you can end up with a cascading effect and further slowing of economic activity because people have less income to spend. If a recession does come about, there are a lot of things that you cannot control, like whether you can maintain a job; however, there are things that you CAN do, which in large part comes down to implementing good foundational financial practices. Perhaps the most important of those is to beef up your savings. If your income is reduced or cut off entirely, having a source of cash to get you through that income disruption is your first line of defense. If you have already established what you would consider your target amount of Cash Reserves, it may be worth further increasing that in the near term to give yourself some added protection. At all times, but especially in difficult economic times, it is also a good idea to look at where you are spending your money and making sure you are managing your Cash Flow well. We tend to think less of this when times are good, but the better you can stretch your income, the more you will be in a position to absorb a recession.  Another perhaps less used strategy you can employ is to activate sources of more passive income (see our February newsletter article). Whether it is because of a disruption of income or because increased costs put a strain on your income, being able to tap into sources of passive income can help you bridge the gap.

In the best of times, managing your money can be challenging and confusing, so when external factors add to the difficulty, it can cause people to get stuck or worse, making poor decisions. If you can arm yourself with knowledge to understand what is going on around you and steps you can take to shore up your financial situation, you will be better for it.

Stewardship Emphasis
If you see someone starting a fire, you should do what you can to keep them from starting it, but once the fire is started, your best bet is to protect yourself from being burned.

The Empowerment Channel    |   Volume CCXXXVII   |    Dedicated to Promoting Financial Education through Stewardship