Macro Musings
▪ Real GDP growth wasn’t particularly strong in Q1 (2.1% QoQ) with the weakest consumer spending since 2022, and so far, data released for Q2 isn’t painting a rosier picture (<2% QoQ). Manufacturing activity is the notable sector that did recover in H1 2026 (from considerable weakness in 2025), but growth is concentrated in defense- and AI-related industries, while much of the broader manufacturing industry continues to struggle. Going forward, AI investment will likely continue to support overall fixed investment, but declining real wages will be a headwind in an economy struggling to grow above potential.
▪ The H1 momentum in the labor market may have run its course, with monthly jobs growth easing considerably in June, along with prior months being revised downward. NFIB hiring expectations are signaling an abrupt slowdown in the months ahead, and with the labor force participation rate in free fall, there is little to suggest that the labor market has indeed turned a corner.
▪ So far, there had been little passthrough of raw materials inflation to finished domestic product, with the initial stages of production exhibiting significantly stronger inflation than the final product. For those consumer goods that have experienced large price increases, like computer software & accessories, their relative weight in the inflation basket is extremely small. With oil now below $80, energy will be much less inflationary, and the stronger dollar can help offset lingering supply shock price pressures too.
Fed & Rates View
▪ We believe that money market futures pricing is inconsistent, with rate expectations pricing in a 25bps Fed hike, immediately followed by a cut later in 2027. Energy prices are fundamentally driving inflation fears (including at the FOMC), but if oil stays below $80/barrel, current market pricing will prove to be aggressive considering the rapid decline in inflation expectations.
▪ Rates View: We recently shifted our view conference (post Warsh’s first press ). We currently expect the Fed to be on hold until late 2026 before returning to easing with 2 rate cuts, reaching neutral of ~3%. There remains little second round passthrough from the oil shock into consumer prices, and growth remains very narrow (concentrated in AI and defense spending). Therefore, we see little justification for a Fed hike. The labor market would need to improve substantially with unemployment falling below 4% and with real proof that productivity has pushed up the neutral rate.
▪ Warsh hopes to bring about a philosophical reset at the Fed, establishing five major task forces – communications, balance sheet (B/S), data, productivity/AI, and inflation frameworks – to rethink core operating assumptions. Leaders of these task forces have been announced, with changes already showing up in the Fed’s communication style (shorter statement and less forward guidance), although conclusions on inflation frameworks and the Fed B/S will likely to be most consequential for markets. We think these taskforces buys Warsh time before any future move.
Market Thoughts
▪ We were of the view that any sort of deal to reopen the Strait of Hormuz (SoH) would see a quick drop in oil prices. Looking back, the price action of Oil and TIPS breakevens largely moved in the way we expected. Though despite the move in breakevens, UST yields have remained stubbornly high due to elevated real rates.
▪ Rates in general were whipsawed in the 1st half of 2026, initially projecting deep cuts to then minor hikes. Swing up in short-term rates has been massive from the recent low, but divergences are forming and overall, we suggest fading the hump in SOFR futures (as we don’t see why the Fed would hike to then ease right after).
▪ As our title implies, we continue to see a more favorable period for the US Treasury market as the summer progresses. In general, the summer is a strong positive period for USTs. We took it a step further and identified patterns when the Fed was on hold, hiking or cutting. We think that the longer-end (10s plus) summer bond seasonals will help turn the rate tide, and that once the Jul FOMC and Aug UST refunding pass, rates will enter rally mode.
▪ Given our enclosed review of curve flattening, without hikes, a bull-flattening move (from the bullish seasonals) would create an opportunity to add to long-end steepeners later in summer.
▪ Lastly, it’s been ground-hog day for stocks (bouncing to all-time highs but in a range) yet there is growing indigestion in US credit. We still see a risk of a drawdown and tighter FCI hitting in 2H26 that would benefit USTs as the Fed would not be able to hike.
Special Topic – Consumer Spending & the World Cup
▪ Revisions to Q1 GDP revealed the weakest consumer spending since 2022, and with consumption accounting for ~70% of GDP, the outlook on overall growth is grim. Sentiment indicators are capturing the persistent weakness in goods spending, and declining real wages pose a risk to services spending in today’s increasingly fragile and historically low savings environment.
▪ The historically high individual tax refunds in the first half of 2026 supplemented spending and helped offset the higher energy bills from the initial oil shock. But in the second half there needs to be better jobs growth in order to boost real aggregate incomes (the ultimate driver of consumption) and to push growth above 2%.
▪ Spending growth has been notably stronger for higher income groups, with the oil shock having a potent impact on gasoline consumption for low- and middle-income groups. So far, higher earners and the wealth effect has been a key driver of spending, where rising asset prices allows consumers to maintain faster than trend growth real spending despite falling real incomes. So, any sort of major market correction materially dampens activity.
▪ The largest World Cup in history is expected to temporarily uplift consumer spending through food service and accommodations spending. We expect the tournament to both pull forward activity and bring in a record number of international tourists and provide some reversal to the declining growth of overseas visitors to the US (which has not fully recovered since the pandemic).
Please see the PDF report link above for the full write-up with charts and forecasts…