A crucial earnings season

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. President Donald Trump said that he does not intend to fire Fed chair Jay Powell yesterday, despite complaining about Powell’s performance over the weekend. In similarly good news, Treasury secretary Scott Bessent told investors that the US-China trade dispute is unsustainable and that a deal will be cut. It’s unclear if Bessent really has the president’s ear, but futures markets are looking favourably upon both statements. It looks like we will see some positive market moves today. Email us: robert.armstrong@ft.com and aiden.reiter@ft.com.

Earnings season: watch the industrials

With the stock market leaping and diving in response to political news, it is easy to forget that sometimes companies provide real live financial information, and that it matters. First-quarter earnings season is here. Early indications are that this quarter may look a bit like the last: good results for the period that just ended, but unpleasantly hazy guidance about what’s next, given trade war uncertainty. The big bank results from last week conformed with this pattern.

In other words: hard data good, soft data bad. But it is possible that some hard facts about the effects of the tariffs may begin to come through soon. What can it be, and how may stock prices respond? An important bit of context, which Unhedged has mentioned before, is that Wall Street analysts’ estimates of this year’s earnings do not seem to incorporate significant impact from the swinging tariff regime announced on April 2 (and modified since). Below are two charts from Scott Chronert’s strategy team and Citigroup. Start with the one on the right, showing S&P 500 estimates for the first quarter and the full year. First-quarter estimates are unchanged; annual estimates have fallen a per cent or two in the past three weeks.

Yet, that is not the whole story. The left-hand chart shows the percentage of estimate changes that were upward; at a bit more than 30 per cent, it is very low in historical terms. So a lot of analysts are bringing their estimates down — very slowly. Unhedged predicts more cuts to come.

Going forward, we will be paying particularly close attention to the results of big US industrial companies — for two reasons. They are sensitive to businesses’ capital expenditure plans, which in turn reflect the level of uncertainty created by the trade war. And many of them also have global supply chains, and so what they say about the profit impact of tariffs will be instructive. 

The industry is already not in fighting shape. Below is the manufacturing new orders section of the ISM manufacturers survey; a score of 50 or less indicates decline. It shows that the US industrial economy has been in a slump since early 2022. A nascent recovery in late 2024 has been snuffed out:

Here are the stocks of a bunch of industrial companies, both general equipment makers (Rockwell, Stanley, Parker, Ingersoll) and Aerospace (GE and RTX). They have been hit hard already. 

Nicole DeBlase of Deutsche Bank points out that, for example, 50 per cent of Rockwell’s revenues are tied to capital spending plans, and 15 per cent of Stanley’s cost inputs come from China. A lot of that has been priced in, but maybe not all of it. Nigel Coe’s team at Wolfe Research runs a survey of 50 equipment distributors. The March edition of the survey is the most negative since the early days of the coronavirus pandemic. Coe writes that despite low expectations, “we are no longer planning on a short cycle industrial recovery”.

GE and RTX reported yesterday. The market response is visible in the top two lines of the chart above. Revenue and earnings were strong at GE and very solid at RTX. The big difference was the tariff outlook. GE said it expected a $500mn cost hit from tariffs as currently expected (for scale, that is equivalent to 6 per cent of the $7.6bn in pre-tax income the company earned last year). The market seems unsurprised by that estimate and the stock rose. RTX, on the other hand, seemed to surprise analysts with an $850mn tariff cost estimate (equivalent to 14 per cent of last year’s $6.2bn in pre-tax earnings). That breaks down as follows: $250mn from the tariffs on Canada and Mexico, $250mn from China, $300mn from the rest of the world, and $50mn for steel and aluminium. The stock fell 10 per cent on a day the wider market was up 2 per cent. 

RTX will not be the last unpleasant surprise of this earnings season.

US inflation expectations

An astute reader wrote to us to argue that we should have looked at two-year expectations, rather than 10-year expectations, to gauge how the market was interpreting the inflation implication of the “liberation day” tariffs. Quite right: the gap between short-term and long-term inflation expectations has been widening for a while. In the chart below we use inflation swaps (a liquid financial contract used by hedgers and speculators) as our proxy for inflation expectations, as break-even inflation (nominal Treasury yields minus inflation-protected yields) currently have some technical issues at short maturities:

We got a series of hotter CPI readings early in the year, boosting short-term expectations, while the Fed held rates steady, holding down the long end. Immediately after “liberation day” there was an acceleration of that trend: the market seems to expect some inflationary flow-through from sweeping tariffs, particularly in the next year, but does not expect the inflationary impacts to last, either because the inflationary effect of tariffs is transitory or because it expects an inflation-killing growth slowdown, or both. 

Since Trump’s announcement of the 90-day pause on the non-China “reciprocal” tariffs, all three series are down a bit. This is a bit surprising. Torsten Slok, chief economist at Apollo, recently noted that 37 per cent of goods from China were intermediate goods, or goods that go into other US products. Higher tariffs on China, and a higher effective tariff rate overall, could raise prices in the short-term meaningfully, particularly for US manufacturers. A growing rift with China could raise longer-term inflation, too.

According to Guneet Dhingra, chief US rate strategist at BNP Paribas, recent flatness on the one-year inflation swap could be from uncertainty about a few crucial factors:

A lot of people think from this point on there is less [impact from]. . . significantly higher [tariffs] on China; there is not much more inflationary upside. Our view is that how corporations in the US absorb tariffs will determine how short-term inflation swaps looking going forward . . . [The market] will get a better indication in the next few months with upcoming [inflation reports] and company earnings reports.

There are also questions around the sequence of economic events. Will growth slow down before inflation picks up, leading to a Fed rate cut? Or will inflation rise first, and tie the Fed’s hands? Like all data, the inflation data is a bit hard to read right now and could remain so as the Trump White House continues to vacillate on its tariff strategy. But the soft data suggests that more inflation is coming, and soon.

(Reiter)

One good read

Conclave players and their odds.

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.