The Embarrassing Truth About Tariffs Why is Trump so upset about Federal Reserve economic research into his trade policies?

The White House this week opened a new front in its war on the Federal Reserve: a fight about Fed research on the consequences of President Trump’s tariffs. If the tariffs are such an unambiguous economic and political winner, why is the Administration so defensive about them?

The flap concerns the analysis we told you about last week by four economists at the Federal Reserve Bank of New York. They found that American households and businesses are bearing nearly 90% of the cost of the Trump tariffs, contrary to Mr. Trump’s claim that foreigners will pay.

Clearly the White House is worried that voters might conclude this research aligns with their own experience. Kevin Hassett, director of the National Economic Council, took to CNBC Wednesday to pan the New York Fed research as “the worst paper I’ve ever seen in the history of the Federal Reserve System” and suggested the people who wrote and published it should be “disciplined.” Disciplined how? Put in stocks? For a tariff paper?

The Fed analysis aligns with other research into the distribution of tariff costs from Harvard economists and Germany’s Kiel Institute—and with common sense. There isn’t widespread evidence that foreign producers are cutting their prices to offset the tariffs, the main mechanism by which foreigners would “pay” for the border taxes.

Nor is the dollar strengthening, which is the other possible mechanism for making foreigners pay (we’ll spare you the equations). Instead the tariffs are causing an increase in post-tariff prices of those goods that are still imported, alongside a modest decrease in the volume of imports. Americans pay higher prices, or “pay” in the form of less choice.

In his more honest moments, Mr. Trump admits this is the effect, if not the intention, of his tariffs. That’s what he meant when he said last year that Americans may have to buy fewer dolls for their children as a result of his trade policies. The handful of economists who support his tariffs believe the border taxes rebalance the global economy specifically by deterring American consumption.

The Fed research and similar papers try to put some numbers on these phenomena. The serious kernel of Mr. Hassett’s complaint, to the extent there is one, is that the New York Fed economists overlooked a wide range of other ways the tariffs could affect the U.S. economy, such as stimulating reshoring of production and an increase in domestic wages.

But such an analysis also probably wouldn’t flatter the Trump tariffs. So far the manufacturing boom Mr. Trump promised hasn’t appeared, as manufacturing jobs are down over the last year. The New York Fed and other research on cost distribution shows one reason why: To the extent American companies eat some of the costs of tariffs, that’s less cash available for investment and hiring.

The Trump economy has been as healthy as it is despite the tariffs, not because of them. The market response to his April 2025 “liberation” tariffs was so negative that the President quickly withdrew them and negotiated lower tariffs as part of “trade deals” that may turn out to be partly illusory. He has also laced the tariffs with multiple exemptions. A dollop of tax reform, a big dose of deregulation and an AI investment boom are allowing the economy to cope with the tariff distortions and uncertainty.

The attack on the Fed over this research is a symptom of the political problem the White House is encountering from tariffs. Thirteen months into Mr. Trump’s term and with elections looming, opinion polls show voters remain worried about the economy. This implies they don’t see a payoff from the tariffs (other than what they’re paying at the store).

Mr. Trump’s ire at current Fed Chairman Jerome Powell increased the more Mr. Powell warned that tariffs might raise prices. The Administration may be trying to warn Kevin Warsh, Mr. Trump’s nominee to replace Mr. Powell, away from a similar approach.

Here’s a better idea: If your tariff policy is so unpopular that you have to bully the central bank into not talking about it, maybe it’s time for a new policy.

WMT yesterday:

prices are rising on imported items and prices overall are still significantly elevated compared with the pandemic period, he said. In the U.S., Walmart prices for groceries grew less than 1% in the most recent quarter, while prices for general merchandise items rose 3.2%, a higher jump than the preceding quarter. Walmart expects similar price movements for the current quarter, in part due to the cost of higher tariffs, said Rainey.

Bank of America internal data:

Tariff payments per small business client were up 142% YoY in January on a 3-month moving average. And a recent analysis from the NY Fed found that US import prices for goods subject to the average tariff increased by 11% more than those for goods not subject to tariffs – underscoring that US firms and consumers continue to bear the economic impact of the high tariffs imposed in 2025.

• America Imported a Record Amount Last Year Despite Seismic Trade Policy Changes December trade deficit surged, capping turbulent year after tariffs

Imports to the U.S. grew to a record high in 2025, leaving the trade deficit little changed despite steep Trump administration tariffs aimed at closing trade gaps.

The nation’s trade deficit—the gap between imports and exports in both goods and services—was $901.5 billion last year, slightly smaller than the $903.5 billion deficit recorded in 2024, the Commerce Department said Thursday. The small change shows America’s role as a heavy net importer remains intact, at least thus far, despite seismic policy shifts during the year.

There were big swings in trade patterns along the way, however, including an early-year surge in imports as companies tried to get ahead of new tariffs. That surge rapidly reversed after some of the tariffs were rolled back and businesses adjusted to the new trade regime.

Overall, imports last year were $4.334 trillion, up about 5% from the prior record of $4.136 trillion in 2024. Exports were $3.432 trillion, up about 6% year over year.

Goods imports for 2025 totaled $3.44 trillion last year, about 4% greater than in 2024.

The trade deficit in goods last year rose to a record $1.241 trillion, up from $1.215 trillion in 2024.

(Bloomberg)

• On Thursday, Walmart also said consumers continue to spend cautiously, especially low-income shoppers. In the U.S., its largest business by revenue and profit, profit margins grew thanks to grocery sales, membership through its Walmart Plus program and advertising sales. But that growth was offset by slower sales growth in general merchandise, a dynamic that reflects shoppers giving priority to their spending needs. (BB)

Private-Credit Warning Signs Flash After Blue Owl Unloads $1.4 Billion in Assets The sale raises fears that the industry’s efforts to court individual investors will suffer

Wall Street has been eagerly selling private credit as a hot opportunity for individual investors. That sales pitch just got tougher.

Blue Owl Capital, a poster child for the industry, said it is liquidating $1.4 billion in assets to raise money to pay out individuals who bought into some of its funds in their heyday but now want to get out. The firm hoped the sale would shore up wobbling investor confidence.

Instead, the opposite happened. Stocks across the private-fund industry slid as the deal raised questions about how much fund managers can count on individuals to stay invested in hard-to-sell assets for the long term.

Blue Owl’s stock dropped 10% at one point Thursday and closing down nearly 6%. Shares of other private-credit titans also sank, with Apollo Global Management and Blackstone both falling about 5%.

“Right now it’s reducing confidence and reducing what anyone is willing to pay for these stocks or assets,” said Evercore Senior Research Analyst Glenn Schorr.

Private-credit funds use client money to make loans, largely to junk-rated companies, earning hefty interest payments that are handed out to investors through dividends. Stocks of these fund managers soared in recent years, in part on optimism that they could raise trillions of dollars from individual investors. That is already happening through funds targeting wealthy investors, like the Blue Owl one that is under pressure. And the industry is taking steps to make private fund investments available through 401(k) savings plans.

But the Blue Owl sale adds to a growing body of evidence of a disconnect between fund managers and individual investors. In private credit, firms buy harder-to-sell assets for longer periods of time, with the understanding their clients will be willing to stomach some turbulence in the middle. Retail investors, however, are accustomed to trading out of investments whenever they choose.

There are other signs that individuals are souring, including a jump in redemption requests at the end of 2025. More worrying to stock analysts: the flow of new investments that were expected to fuel future earnings growth is also slowing.

Inflows to “semiliquid” business development companies, or BDCs, that Blue Owl and others have sold aggressively to wealthy individuals dropped an average 15% over the last three months, according to research by Fitch Ratings. Monthly inflows to the largest such fund, which is managed by Blackstone, dropped to $600 million in January from $1.1 billion in November.

Fund managers say inflows still far outweigh redemption requests, reflecting pent-up demand from wealthy individuals, most of whom still don’t own much private-credit.

“If headlines stay bad and retail keeps reading them, we can expect more headwinds on flows into these funds,” said Ben Budish, a stock analyst at Barclays covering fund managers. (…)

More recently, Blue Owl sold loans held in three of its BDCs to large pension funds and insurance companies for 99.7 cents on the dollar. (…)

“They sold 30% of the portfolio at par and that’s great,” Evercore’s Schorr said. “But it also made people doubt and wonder what the rest of the portfolio in the fund is worth.”

This blog has been warning about private credit since last October.

• Give Them Credit! (October 3, 2025) highlighted the First Brands collapse could well be the first of many corporate accidents.

• Credit and Freedom (January 2, 2026) with Chris Whalen warning that Cracks Widen in US Credit, that the economy may not be as solid as many think:

The growing number of individual and corporate insolvencies are part of a rebound of a long-term trend of falling defaults. For more than a decade, total bankruptcy filings fell steadily, from a high of nearly 1.6 million in September 2010 to a low of 380,634 in June 2022. Total filings have increased each quarter since then, but like loan default rates, they remain far lower than historical highs.

Like credit metrics, the statistical measures of default reflect a growing tendency for negotiation rather than formal events of default.  Some estimates suggest that 1 out of three insolvencies are restructured out of court. (…)

One way to measure the stress building in private equity and credit is the poor performance of lenders to private businesses. Long-term equity returns for business development companies (BDCs) have been hammered since the middle of 2025 (…) “Short sellers are taking note of rising signs of stress within the private credit market, and using publicly traded BDCs to signal that outlook,” (…)

PIK or “Payment-in-Kind” refers to a mystical financial arrangement where interest or dividends are paid with additional securities, goods, or services instead of cash, allowing companies to conserve cash flow but increasing debt principal. PIK is commonly seen in high-risk sectors like leveraged buyouts and venture debt, with examples including PIK Notes and PIK Interest. But there are literally thousands of private equity financed companies now using PIK to avoid default.

Income from payment-in-kind debt, which allows borrowers to defer interest and can signal an inability to pay with cash, has been rising across BDCs, reaching 7.9% in the third quarter, according to data from Raymond James. In the third quarter, 3.6% of investments across BDCs were on non-accrual status, a designation that indicates a lender expects losses, Raymond James data show.

Like REITs, BDCs are pass through vehicles that must pay out most income. “BDCs still accrue the PIK loan coupons as non-cash income, but lack the corresponding cash to pay the required dividends, to maintain their favored IRS treatment,” NDP notes further. “If they lose that tax treatment, there is risk that such PIK loan coupons become taxable at the BDC level, rather than treated as simply passed through to BDC shareholders for taxation.  Then, the BDCs would lack the cash to pay the IRS, too.” (…)

We expect to see a growing number of BDCs, private equity sponsors and other parties forced to recognize asset impairments and related losses in the New Year. The backlog of private equity companies using PIK or other means to avoid bankruptcy is going to be cleared out substantially as it becomes clear that merely lowering short term interest rates will not make moribund PE companies attractive to investors. (…)

Lend More Upon Default (LMUD) has concealed the scope of the disaster and even pushed down reported loan default rates, but we suspect that 2026 earnings results will see the benign trend in bank credit defaults come to an end.

Classic! Too much money always, always results in speculative behavior, more so when people forget that economic cycles are actually not dead. Seeking higher returns, investors drift away from basic investment discipline and/or over-concentrate to one sector.

Greedy underwriters are quick to sniff it, leading to weak underwriting, limited transparency, limited due diligence, and loose covenants. Investors find comfort in “packages” forgetting, as Jim Chanos put it, that “We rarely get to see how the sausage is made.”

The mix and quality of risk now matter more than the quantity of risk one takes. In our view, 2026 should be a year to upgrade portfolios rather than stretch for yield, including moving up in quality where we can, locking in fixed-rate income where it is still adequately compensated, and leaning into collateral-backed structures that offer both contractual cash flows and protection in downside scenarios. (KKR)

Maybe you missed the last part of my February 18 post:

The share of private equity-backed companies that deferred cash interest payments ticked higher for a third consecutive quarter, pointing to growing signs of stress, Rene Ismail reports.

Data from valuation firm Lincoln International show that 11% of fourth-quarter borrowers paid interest in-kind, which is when creditors are given more debt in lieu of cash. More than 58% of those loans featured so-called “bad PIK,” meaning that borrowers opted to delay interest payments during the life of the loan versus when the debt was originated. Lincoln analyzed more than 7,000 companies during the fourth quarter.

“Companies we flagged as having bad PIK went from roughly 40/60 debt-to-equity, which is reasonable, to about 76% debt today — that’s a sign of stress,” said Ron Kahn, global co-head of valuations and opinions at Lincoln, which has data going back to the fourth quarter of 2021.

Bad PIK was in 6.4% of private loans last quarter, up from 6.1% in the three months prior and substantially higher than the 2.5% ratio recorded in the last three months of 2021.

And don’t presume this is limited to private credit.

The backlog of unsold companies in private equity is monumental. As the FT notes: “Private equity firms sell assets to themselves at record rate.” This will not end well. And the end may begin in 2026 as private equity companies fail in growing numbers.

The strong rally in silver and gold, and the weakness of crypto tokens, are leading the decline in US fortunes when it comes to the equity markets. Literally dozens of crypto ventures have failed in the past year, notes Comsure. Crypto exchange collapses have led to $30–50 billion in investor losses, the UK consultancy reports. But the greater concern is the mounting backlog of corporate insolvencies, a real and growing danger that could push the US into recession even as short-term interest rates fall.

As I wrote on January 2:

This right when the US government is taking several regulatory and executive actions to “democratize” access to private equity and private credit for retail and retirement investors.

Among many measures, the SEC is exploring changes to the “accredited investor” definition to focus more on investor sophistication rather than strictly wealth or income criteria.

How will the SEC objectively measure sophistication?

Sophistication is not intelligence, and certainly not judgement (remember LTCM).

Wealth and income are much better measures of one’s ability to weather investment losses than sophistication. This is what the “accredited investor” definition was for.

In today’s WSJ:

The Trouble With Public Access to Private Markets Small investors are unlikely to know what they’re doing—and the effect on public markets would be undesirable.

(…) In this challenging environment, “alternative” managers have begun looking at small investors as a potential solution. Their money is seen as fuel for growth and, perhaps more important, as exit money to satisfy the clamor of current investors who want out.

President Trump (in an August executive order) and the Securities and Exchange Commission have endorsed opening private markets to small investors. But there are pitfalls beyond the obvious problem that small investors may not know what they are doing. One is the effect on public markets.

The number of U.S. public companies exceeded 7,000 in 1997. Today’s total is less than half that and falling. Hamilton Lane reported in 2022 that only 13% of U.S. firms with more than $100 million in sales were public, leaving 18,000 companies out of reach to small investors. Letting small investors into private funds would address this situation, but it could turn out badly for investors and the market.

Most small and intermediate-size companies can be accessed only through exorbitant fees such as the “2 and 20” for venture funds and the multilayer fees for funds of funds. And what will be in it for investors? Will Wall Street share the best private deals with the public or keep them for itself and favored customers?

To broaden access to private markets, we should first restore public markets for small and medium-size companies so that all investors have an array of public and private choices. To do this, we must remove the disincentives that keep smaller companies from going public:

• Congress has interfered with public-company CEO compensation, which has led to a reliance on options and fostered semi-privatization through massive stock repurchases.

• Public-company CEOs have been burdened with unreasonable legal liabilities such as personal responsibility for the accuracy of even the minutest details in all financial statements.

• The costs of issuing public stock and regulatory compliance have become too high for any but giant companies to bear.

• Quarterly reporting and Wall Street demands for immediate “good numbers” have encouraged a short-term perspective, which may foreclose important long-term investments and thinking.

• Because so much stock investing has morphed into index investing, new public companies, which are unlikely to join an index, become orphaned. Having more public companies won’t help this situation, which requires new thinking to solve.

If I were at the SEC, I would be asking: Is it a good idea for small investors to be concentrated in a limited number of giant companies through index funds that are weighted by capitalization and that buy regardless of price? Will exchange-traded funds hold up during the next extended bear market? Their liquidity hasn’t been tested. Are investor funds safe with the few brokerages that dominate the small-investor market? Will Securities Investor Protection Corp. insurance provide enough protection?

The small investor is perennially at risk. As Malcolm Bryan, president of the Atlanta Fed in the late 1950s, said: “We should have the decency to say to the money saver, ‘Hold still, Little Fish! All we intend to do is to gut you.’ ”

But a president aggressively deregulating crypto markets won’t be bothered discussing regulations for small investor protection.

FYI: Crypto exchange collapses have led to $30–50 billion in investor losses

Globally, the crypto and virtual asset industry has seen significant defaults and bankruptcies, both among exchanges and token projects.

• Out of nearly 7 million cryptocurrencies listed since 2021, 3.7 million have failed (i.e., stopped trading or were abandoned).
• 52.7% of all crypto projects have failed, with 1.8 million failures in Q1 2025 alone.

Reasons for Token Failures:

• Lack of utility or use case
• Poor security (e.g., hacks)
• Rug pulls and scams
• Market volatility and regulatory pressure

Total Estimated Cost to Investors:

• Exchange-related losses: Over $30 billion
• Token project losses: Difficult to quantify precisely, but likely tens of billions more, especially from retail investors in failed ICOs, meme coins, and DeFi scams.

Based on the most comprehensive data available, the total estimated global investor losses from failed crypto exchanges and token projects are well over $2 trillion.

Comsure, a business risk advisory service, wrote the above last September 24. Bitcoin peaked at $124,310 on October 7. It’s now $67,530. Some people are silently crying … and praying.

US Poses Greater Security Threat Than China, Canadians Say in Poll

More than half of Canadians say the US currently poses the greatest threat to their country’s security, a stark indicator of how wide the perceived rift has become between the historically close allies.

A survey conducted by Nanos Research Group for Bloomberg News found 55% of respondents believed the US poses the most risk to Canada’s security of any country. Some 15% of respondents said China was the greatest threat, followed by 14% who pointed to Russia.

The poll was taken from Jan. 31 to Feb. 4, shortly after US President Donald Trump made a series of threats against Greenland, publicly complained about NATO and said he would be prepared to increase tariffs further on Canada. (…)

Trump’s tariffs have also pushed Canada closer to China. The two countries agreed on a deal to lower tariffs on Chinese electric cars and Canadian food products. His government is also seeking Chinese joint-venture auto investment — an unthinkable step before Trump returned to the White House.

Double Feature: Durable Goods Orders & Industrial Production

What is often mistaken as broad resilience in business investment over the past year has actually been a heavy concentration of spending in the AI and broader high‑tech build out. It is not so much a rising tide that lifts all boats as it is condensed activity in one sector that masks a struggle in industries not directly tied to the tech build-out. Today’s data point to an encouraging growth pick-up outside of high-tech.

That dynamic is clearly visible in the durable goods data: orders for computers & related products rose 13.7% over the past year, running at nearly four times the pace of underlying core capital goods.

The same concentration shows up on the production side. Domestic output of high‑tech goods—including computers, communications equipment, and semiconductors—is up nearly 9% through January, while non-energy production excluding these components is up just 2.2%. Even trade flows tell the same story where growth in U.S. imports last year was largely driven by high‑tech equipment, with non‑tech import categories losing momentum.

We don’t see the AI‑driven investment cycle fading anytime soon, and capital flows into that space are likely to continue.

This morning’s data show there are early signs that more traditional areas of capex are beginning to firm as well. Core capital goods orders are stabilizing and output excluding high‑tech is starting to improve. Recent tax incentives in the One Big Beautiful Bill Act are supportive of broader investment, and the early‑year pickup in commercial and industrial lending suggests firms are becoming incrementally more willing to finance capex beyond AI. (…)

Orders excluding transportation have firmed in recent months and rose 0.9% in January which was three-times the consensus expectation.

Orders for core capital goods (nondefense ex. air) looked better too, up 0.6% in December (twice the 0.3% expectation), and that better-than-expected reading came on the heels of an upward revision. Shipments of core capital goods rose 0.9% which also handily exceeded expectations, but remains consistent with our expectation for real equipment investment to rise at a near 4% annualized clip in Q4 when data print Friday.

Industrial production picked up at the start of the year, rising 0.7% in January, though downward revisions to year-end take some of the shine off the data. Output was supported by firmer utilities output, but most of the strength stems from a sizable pickup in manufacturing output.

Total manufacturing production rose 0.6% in January, posting the strongest monthly gain in nearly a year, and activity looks fairly broad based under the headline. Durable goods production was responsible for most of the strength (+0.8%) with all but the aerospace industry posting a rise in output. Nondurables industries were more mixed (+0.4%), with four of eight industries seeing output fall and a rebound in chemical output and some others offsetting declines.

You do not need to do a deep dive to find the theme of a tech-concentration in the industrial production data. Just look at the index levels. The Federal Reserve sets them all equal to 100 in 2017. The manufacturing index in January came in at 97.5 meaning manufacturing output, in volume terms, is 2.5% smaller than it was almost a decade ago. Yet the category “selected high-technology industries” came in at 184.7 the same month. This grouping includes output of computers, communications equipment, semiconductors and related electronic components.

While high-tech continues to outpace non-tech focused output, we see signs of recovery. Excluding high-tech, manufacturing output rose 0.6% in January, marking the fastest monthly increase in nearly a year with this measure of production matching its highest index reading of the past two and a half years.

The fact remains that overall manufacturing production is very spotty with no clear upward trend:

From BofA:

Data suggests that US new motor vehicle (“auto”) sales began 2026 on a soft note. On a seasonally-adjusted annualized rate (SAAR), sales fell to 15.4 million in January, from 16.4 million in December 2025, according to data from the Bureau of Economic Analysis (BEA). (…) auto sales have struggled to return to their 2019 level over the past six years, apart from an immediate post-pandemic rebound and a brief surge in early 2025, when sales rose in anticipation of higher prices due to tariffs.

We think affordability is a key factor likely driving weaker auto sales. Car prices have risen significantly over the past six years, though that rise appears to have largely stopped for now. New car prices are up around 22% on 2019 levels, while used car prices have jumped around 30%, according to data from the Bureau of Labor Statistics (BLS). At the same time, the cost of insuring a vehicle has risen significantly. When combined, these hikes may have curbed vehicle demand, especially compared with other areas of consumer discretionary spending. (…)

Exhibit 5 shows that the average auto loan payment from Bank of America customer accounts has risen most for younger Millennials (ages 30-36), with the average auto loan payment from this cohort up nearly 60% from 2019. Older Millennials and Gen Z have also experienced sizeable increases, each exceeding 40%.

In some respects, it makes sense that younger Millennials have seen the largest rises in average loan payments. In the early 2020s, many were likely engaged in household formation and potentially having children, all of which can precipitate the need for a new or used – often larger – car. And they were doing this at a time when car prices were elevated and auto loan financing rates had risen as a result of Federal Reserve rate hikes.

Fed Minutes Reveal Little Appetite for Rate Cuts Some officials favored more neutral language pushing back against the prospect of future rate cuts

Federal Reserve officials signaled little appetite for reducing interest rates at their meeting last month, with most indicating they wanted to see further progress on inflation before considering any more cuts—a process that could take months.

Moreover, even though two officials opposed the decision to hold rates steady at their Jan. 27-28 meeting and favored a cut, minutes of the meeting showed that other officials would have supported more neutral language characterizing the prospect of a rate cut or a rate increase as evenly balanced.

The minutes said those officials would have been comfortable changing the Fed’s carefully drafted postmeeting statement to reflect the possibility that rate increases could be warranted if inflation continued to run above the Fed’s target.

“Several participants indicated that they would have supported a two-sided description of the committee’s future interest rate decisions, reflecting the possibility that upward adjustments” in interest rates “could be appropriate if inflation remains at above-target levels,” said the minutes. (…)

The minutes, released Wednesday with a customary three-week lag, revealed that more officials were less worried about the labor market than they had been and more apprehensive about inflation.

Most officials, the minutes said, cautioned that progress bringing inflation down “might be slower and more uneven than generally expected.” The risk that inflation might run persistently above the Fed’s 2% goal “was meaningful,” they said. Likewise, the Fed’s staff inflation forecast described an interval of more persistent, above-target inflation as “a salient risk,” according to the minutes.

The minutes laid bare a lingering divide over where to set the bar for lowering rates. Several officials said they would still be open to cutting so long as inflation declined in line with their expectations. But a somewhat larger group said they had a higher bar that called for a clear indication that inflation progress “was firmly back on track” before cutting. (…)

• Inflation Is Down, But Americans Still Feel an Affordability Squeeze

 

 

This last chart plots my “Inflation on Essentials” series (CPI-Food + Energy + Shelter) in YoY (dash-left) and absolute vs Headline CPI. Current “Inflation on Essentials” costs are 30.3% higher than in Jan. 2020 while total CPI is 26.3% higher. YoY inflation is +2.7% on Essentials vs +2.4% overall.

The Atlanta Fed just released its Business Inflation Expectations survey:

Firms’ year-ahead unit cost expectations decreased to 1.9 percent.
Firms reported a median 3.0 percent (3.7 percent mean) price increase over the past 12 months and a median 3.0 percent (3.1 percent) expected price increase over the next 12 months. Realized price and expected price both increased from November (3.0 percent median realized price increase, 3.0 percent median expected price increase).

• Overall, firms are optimistic on sales and margins:

• They expect to raise their prices by 3.1% this year vs overall inflation of 1.9%.

Axios:

The Supreme Court could rule on the legality of President Trump’s tariffs as soon as tomorrow, and a raft of analysis will surely follow as economists and Wall Street researchers parse the fallout.

Just yesterday, Trump economic adviser Kevin Hassett called a paper from researchers at the New York Fed “an embarrassment” and said its authors should be “disciplined.”

The research found that American consumers and companies paid about 90% of the cost of Trump’s tariffs last year following several other reports with similar conclusions.

The dustup was a reminder of the trigger-happy political atmosphere around economic research, heightening concerns that Trump’s criticism is muffling commentary from Wall Street.

• Multiple firms have been toning down and censoring their research for fear of angering the White House, Bloomberg reported.

In August, Goldman Sachs chief economist Jan Hatzius put out a report also saying Americans pay some portion of the tariff cost. Trump then posted the bank’s CEO Davis Solomon should fire the well-respected analyst.

• Earlier this year, Treasury Secretary Scott Bessent said the head of Deutsche Bank called him to say the bank “does not stand by” an analyst report that suggested European investors may step up sales of U.S. assets. The bank later said the independence of its research was “sacrosanct.”
• And last April, a JPMorgan analyst voluntarily redacted his analysis of White House policy, literally blacking out portions of a report.

Asked whether the White House comments chill the speech of economists and analysts, spokesman Kush Desai said:

• “What should chill the work of these economists is the fact that they have consistently beclowned themselves by pushing one doom-and-gloom prediction and ‘study’ after another about President Trump’s tariffs.”
• Trump, Desai said, “implemented a historic tariffs agenda while cooling inflation, renegotiating trade deals, accelerating economic growth and securing trillions in investments — the exact opposite of what these economists predicted would happen.”

Wall Street research isn’t like a policy white paper or even an academic report. It’s intended for investors.

• “I don’t think people in Washington understand what our research reports are for,” one person at a top Wall Street bank tells Axios. “They’re written for clients.”
• Banks have a fiduciary duty to their customers. They can’t really change their findings to suit the administration.
• This person’s advice to bank analysts: Be clinical, not colorful and do good work for your clients and you’ll “be fine.”

“I try not to be political, but on a scientific question or an economic question, I’m going to state exactly my mind,” says David Kelly, chief global strategist at JPMorgan Asset Management.

• Analysts say what they think, he says, and those that don’t have “no business doing the job.”

The findings of the New York Fed report that Hassett criticized are not controversial among economists both conservative and liberal.

• “I think the findings of the paper are consistent with what standard economic analysis would suggest,” Michael Strain, an economist at the conservative American Enterprise Institute, tells Axios.
• “I trust the Fed research,” Kelly says. “I actually came up with the same result.”

The Supreme Court could issue its tariff ruling tomorrow or next Tuesday or Wednesday.

• As of this morning, there was a 26% chance the justices uphold the tariffs, per Polymarket.

GOP angst over voter turnout builds as losses pile up

Republicans are getting crushed in scores of state and local races, raising deep concerns about a deflated base refusing to show up to vote even in the most pro-Trump areas.

The numbers are startling. In race after race, Democrats are outpacing their 2024 performance by double digits, a clear sign of a yawning enthusiasm gap.

Democrats have outperformed former Vice President Harris’ 2024 numbers by an average of 10.5 percentage points in the 20 state legislative districts that’ve held special elections this year.

• Democratic candidates outperformed Harris by even more — an average of 13.9 points — in the 67 state House and Senate races last year, according to The Downballot, a site that tracks state-level and congressional campaigns.

Republicans’ internal polling is aligning with recent surveys that suggest a downturn in support for GOP candidates.

• Many Republicans trace their troubles to Trump not being on the ballot this year or in 2028.
• But strategists acknowledge that some of his actions — including the administration’s reluctance to release more of the Epstein files — have turned off parts of his MAGA base, while energizing Democrats and anti-GOP independents.
• Polls have shown widespread dissatisfaction with Trump’s immigration crackdown and with how he’s handling the economy.

A big warning sign came Jan. 31, when Democrats snatched a North Texas-based seat in the state Senate. Democrat Taylor Rehmet won the seat by 14 points in a district Trump won by 17 in 2024.

Then, on Feb. 7, Democrat Chasity Verret Martinez won a South Louisiana state House district with a 24-point landslide margin. Trump had won the district by 13 points in 2024.

On Feb. 10, a Republican won a special election for a conservative north-central Oklahoma state House district by 28 points. Trump won the district by 58 points in 2024.

Since the start of the year, Republicans have suffered double-digit drop-offs from Trump’s 2024 performance in state legislative elections in Northern and Central Virginia, New York City, east-central Minnesota, and southeastern Connecticut.

• “While it is tempting for many in our party to wish away these results,” a GOP operative told Axios, “the pattern is clear that there is at least a current 10-point Democratic over-performance from Trump 2024 — and it’s built on a fired-up Democratic base and a sleepy GOP base.” (…)

Some Republicans caution against reading too much into state and local elections, arguing they often don’t reflect national trends.

• They note that Trump’s cash-flush political operation didn’t aggressively work to turn out the president’s supporters in any of the recent elections — something it’ll do in U.S. House and Senate elections this November.
• They also point out that Trump plans to hit the trail aggressively, which they believe will help to turn out his supporters.

“Let’s not pretend a couple of low-turnout special elections suddenly signal a political earthquake,” said Mason Di Palma, communications director for the Republican State Leadership Committee. “They are unique, low-turnout contests driven by highly localized factors.”

AI CORNER

Pentagon-Anthropic battle pushes other AI labs into major dilemma

As the Pentagon and Anthropic wage an ugly and potentially costly battle, three other leading AI labs are also negotiating with the department — and deliberating internally — about the terms under which they’ll let the military use their models.

Defense Secretary Pete Hegseth wants to integrate AI into everything the military does more quickly and effectively than adversaries like China. He’s insisting AI firms give unrestricted access to their models with no questions asked — and showing he’s willing to play hardball to force their hands.

The Pentagon is threatening to sever its contract with Anthropic and declare the company a “supply chain risk” because it’s unwilling to lift certain restrictions on its model, Claude.

• The company is particularly concerned about Claude being used for mass domestic surveillance or to develop fully autonomous weapons.
• The use of Claude in the Nicolás Maduro raid deepened tensions. The Pentagon claims an Anthropic executive raised concerns after the operation, though Anthropic denies that.
• Administration officials say it’s unworkable for the military to have to litigate individual use-cases with Anthropic before or after the fact. “We’re dead serious,” a senior Pentagon official told Axios of the threat to cut off Anthropic and force its vendors to follow suit.

Crucially, Claude is the only model available in the military’s classified systems through Anthropic’s partnership with Palantir.

• Three other models — OpenAI’s ChatGPT, Google’s Gemini and xAI’s Grok — are available in unclassified systems, and have lifted their ordinary safeguards as part of those agreements.
• Negotiations to bring those companies into the classified domain are now more urgent as the Pentagon ponders how to replace Claude if necessary — a process a senior official conceded would be massively disruptive.
• Anthropic says it remains committed to working with the Pentagon, despite the public feud, and both sides say they might still come to an agreement.
• One acknowledged that the fight with Anthropic was a useful way to set the tone for negotiations with the other three.

Officials are adamant they won’t budge on a standard allowing the Pentagon “all lawful use” of the AI models, and a senior administration official said one of the three labs already told the Pentagon it was “ok with ‘all lawful use’ at any classification level.”

• A source familiar told Axios that it was xAI, whose founder Elon Musk has ripped rivals like Anthropic and OpenAI as “woke” for their approaches to safety. xAI did not respond to multiple requests for comment.
• Notably, xAI was the only bidder out of the frontier labs in the Pentagon’s autonomous drone software contest.
• OpenAI is bidding in a limited way to translate voice commands into digital instructions, but not for drone control, weapon integration, or target selection.

The senior official said the administration was confident the other two labs would agree to “all lawful use” across both domains. But sources familiar with those dynamics tell Axios it’s not nearly that clear-cut.

• An OpenAI spokesperson told Axios that moving into classified work “would require us to agree to a new or modified agreement.” Google declined to comment.
• The “all lawful use” requirement is hardly relevant for unclassified work. “People are going to use this thing to make their PowerPoint slides a little bit more quickly and easier. They’re not going to be developing autonomous weapons,” one source said.
• But applying that standard in the classified domain poses thorny ethical dilemmas.

While Anthropic CEO Dario Amodei has been the most vocal about the risks of advanced AI, executives at OpenAI and Google share some concerns about how their models might be used, sources familiar with those dynamics say.

• The companies may also fear revolts among their engineers, like the one Google experienced in 2018 over a previous initiative, Project Maven, that involved using AI to analyze drone footage. Google walked away from that deal after a damaging internal fight.

Then there’s the matter of how you ensure the Pentagon is complying with whatever usage terms have been agreed, or even with the law.

• “The whole game” is building infrastructure that ensures what’s being deployed is safe, and having oversight on the back end into how it was used, one source said.
• The source was skeptical of Anthropic’s claim that the company has sufficient visibility into Pentagon operations to ensure it’s comfortable with every use of its model.
• A separate source said Anthropic does have visibility and is confident its usage policies are followed.

One source familiar with the ongoing discussions said one issue is that the companies themselves don’t fully understand how their models will respond in certain scenarios, or why.

• “That is more challenging than just figuring out like, ‘Hey, will this metal withstand this degree of heat or that degree of heat?'”
• The source added: “If there’s a one in a million chance that the model might do something unpredictable, is that one in a million chance so catastrophic that it’s not worth taking a 1 million chance?”

If an AI model enables an autonomous weapon to near-instantly take down dangerous drone swarms, is it ethical to deploy it when there’s some small chance it could also fire on a civilian flight?

• Those are the sorts of questions the labs are grappling with.

The Pentagon’s position is that such decisions should be made by the military, not by executives in Silicon Valley. Anthropic and its rivals are under pressure to decide whether they can live with that.

How’s the Rule of Law in the USA these days?

There’s also the Rule of Money with Elon Musk putting pressure on everybody.

Shouldn’t this debate involve other world instances, countries?

BTW: The U.S. is assembling the most air power in the Middle East since the 2003 invasion of Iraq, The Wall Street Journal reports.

• According to Article I, Section 8 of the U.S. Constitution, only Congress has the explicit power to formally “declare war”
• Instead of formal declarations, modern conflicts (like those in Iraq and Afghanistan) are typically conducted via an Authorization for Use of Military Force (AUMF) passed by Congress.
• The President is widely recognized to have the authority to respond to sudden attacks on the U.S. or its interests without prior congressional approval.

In a social-media post on Wednesday, Trump said the fleet of US ships he’d ordered to the region, led by the USS Abraham Lincoln aircraft carrier, is “ready, willing, and able to rapidly fulfill its mission, with speed and violence, if necessary.”

Via John Authers:

Prediction market bettors now put the odds of a US attack at around 70%, while crude oil prices are rising. Brent surged 4.3% on Wednesday to top $70 once more:

Crude oil and gasoline prices troughed in the US in December. Oil is up 15% and gas 8% since.