As economy softens and tariffs head for final reckoning, investors feel lucky

(Originally published Sept. 11 in “What in the World“) Don’t get too comfortable.

UBS warns that, even as the stocks and bonds rally amid confidence in lower interest rates, markets may become increasingly volatile. It’s not difficult to see why.

The S&P500 has climbed more than 17% since April, when investors were freaking out over Trump’s tariff policies. Yields on 10-year U.S. Treasuries have fallen 124 basis points, to just over 4%. And while the dollar has kept weakening, it has weakened by only 1.6% after its roughly 10% plunge since Trump’s inauguration.

Why the optimism? Trump’s tariffs turned out to be not as bad as he threatened, but they’re still here and will likely survive rulings that they are illegal. The U.S. economy’s outlook, meanwhile, appears increasingly gloomy. The latest harbinger of economic doom? Falling lumber prices.

According to The Wall Street Journal, lumber futures have fallen 24% since soaring in early-August to a three-year high. Importers stocked up early this year in anticipation of Trump’s tariffs, only to run into a construction slump that has left them with a supply glut. Wood prices, the Journal says, have in the past been a reliable gauge of the housing market and the broader economy.

Would that wood was the only thing rotting in Trump’s economy. The Bureau of Labor Statistics said Friday that U.S. employers added 22,000 jobs in August, well below the 75,000 that economists predicted, while unemployment rose to 4.3%. That data followed BLS data last week that new job openings in July fell 4% from the same month a year ago, their lowest in 10 months. The bureau’s similarly downbeat report for July, with its downward revisions for May and June, prompted Trump to fire the bureau’s head, Erika McEntarfer. But retaliation hasn’t fixed the job market. On a quarterly basis, job openings fell 2.5% in the three months ended July 31 from the same period of 2024. On Tuesday, the BLS announced an even bigger downward revision, this time saying that the U.S. job market created only 879,000 jobs in the year ended March 31, less than half what it had originally estimated. It was the biggest revision since 2009.

The market’s optimism is rooted almost entirely in the expectation that the U.S. Federal Reserve will next week respond to this weakening job market by making the first of not just one, but three, cuts to its benchmark interest rate before the end of the year—lowering it by 25 basis points in three subsequent meetings of the Federal Open Market Committee, to 3.5% and 3.75% from its current range of between 4.25%-4.5%.

As jobs weaken, inflation is starting to show signs of being vanquished, too. The Labor Department said Wednesday that its Producer Price Index rose only 2.6% in August from a year ago, less than economists expected. But even though the New York Fed’s five-year forward shows that investors now expect inflation to run at just 2.34%, one-year-ahead inflation bets are still at 3.2%, suggesting the Fed hasn’t yet managed to anchor inflation expectations. The consumer price index for August is due for release today.

Investors are making the trifecta of economic bets. What could go wrong?