Macro Musings: Output in the first half of the year was below potential with real GDP growth averaging just 1.25%. The big news was July’s NFP jobs report which showed significantly fewer jobs added over the past 3 months (especially after the historic downward -258k jobs data revision). For now, we are torn on the growth outlook but lean bearish. Yes, it can improve into 2026 if pro-growth O-BBB measures ignite dormant demand. Yet, tariffs can hit activity and result in a brief period of stagflation, where growth remains below potential, and unemployment rises above 4.5%, while inflation hovers above 3-3.25%.
Market Thoughts: In our view, various equity metrics (CAPE, prices-to-sales, market-cap to GDP, tech concentration etc.) and risk assets in general, are at bubble levels again (driven by leverage, liquidity, momentum & passive flows). Valuations are being justified because of the belief that trade uncertainty is lifting and thus a Goldilocks scenario will unfold (further driven by AI spending and de-regulation). In our view, risk markets are too complacent (on pure macro risks) and are due for a pullback in the coming weeks. Meanwhile, the rates market will stay focused on jobs vs inflation, so steepeners work either way. We are also paying close attention to overseas rates market dynamics ahead.
Fed and Rates View: We recently pivoted, acknowledging that the window for Fed cuts is narrowing while the bar for multiple or big cuts in 2025 has been lifted. We dialed back our call to two cuts this year pre-July FOMC meeting (but if jobs data continues to weaken ahead it’s possible we see more). In our view, if not for the pressure, the Fed most likely would have cut by now (with an aim of hitting neutral so that it’s easier to respond to future economic outcomes). Even if the Fed cuts a few times, that is not close enough to the lower rates that Trump wants. In our view, Trump will keep putting pressure on everyone at the Fed to cut more, hence our new call is for an additional 100 bps of cuts in 2026.
US Trade Update: As of this writing, there is still no conclusion on the appeals court hearing, though panelists are skeptical about the legality of using IEEPA to carry out trade policy. In the meantime, Trump’s August 1 deadline resulted in trade deals (which are expected to boost the average tariff rate above 15%).
Special Topic - Rhetoric vs Reality of Tariffs and Trade Deals: We explore the impact on investment flows vs fiscal benefits. Tariff revenue will offset some of the O-BBB deficit impact, with a 10-15% tariff rate potentially adding between $2-3T in revenue over a decade. With average tariff rates expected to go above 15%, we can expect imports to fall, and by extension, less USD flows to the rest of the world and less recycling of USD into US investments. Thus, domestic bond investors will likely be forced to pick up the slack and buy more USTs ahead.
