Low Inflation and Slow Economic Growth: Recipe For Fed Ease

The stock market may continue to move up slowly in the face of corporate earnings this week, as there is still time for a trade deal before the August 1 deadline.  Hope for a Fed rate cut at the July 29-30 FOMC Meeting is supportive of stocks, but it is still a long shot without there being a deal with a major trading partner.  A deal could free the Fed's hands, since the macroeconomic data support a decision to ease monetary policy.  

Although Fed Chair Powell maintains that inflation risks outweigh slow-growth risks stemming from Trump's tariff threats, the data released so far suggest the opposite.  Inflation remains subdued and Real GDP Growth was below trend in H125.  Powell has acknowledged the policy implication in a recent speech when he said the Fed would be easing were it not for fear of the inflationary impact of tariffs.  And, to be sure, bigger tariffs are threatened to be put in place on August 1 if trade deals are not made.

The Core CPI remained subdued at 0.2% m/m in June.  While some components posted large gains, very possibly a result of the tariffs, other components were soft and dominated the overall print.  News articles emphasized the increase in the y/y pace to 2.9% from 2.8%, but the uptick had more to do with the very low print in June 2024 than the trend-like print in June 2025.  The annualized m/m change was 2.8% in June and is in line with the Fed's Central Tendency Forecast for 2025.  Besides the direct impact of tariffs not dominating overall CPI inflation, the flat June PPI shows that domestic producers have not boosted prices to take advantage of tariff-impacted import prices.  The PPI measures prices charged by domestic producers, while the CPI measures prices faced by consumers.  The absence of secondary tariff-related price hikes by domestic producers should be a relief to Fed officials that the tariffs may very well have only a one-off effect on prices.

Besides the low inflation prints, a decline in inflationary expectations should please Fed officials.  Both the short- and long-term measures of these expectations in the University of Michigan Consumer Sentiment Survey fell in mid-July.  In particular, the 5-year longer-term expectations have fallen for three months from a peak of 4.4% in April to 3.6% currently.  It is now just above the 3.0-3.2% range of H224.  

One reason for inflation staying low may be the modest pace of wage inflation.  The latter could reflect in part subdued economic activity.  The Atlanta Fed Model estimates Real GDP Growth of 2.4% (qq, saar) in Q225 after -0.5% in Q125.  GDP in both quarters, however, were likely distorted by measurement problems arising from large swings in imports.  Government surveys tend to have trouble capturing the full impact of imports on domestic spending components of GDP.  So, the jump in imports in Q125 (in anticipation of tariffs) held down GDP, although in theory there should have been a corresponding offset in another GDP component.  And, the subsequent drop in imports appears to be boosting GDP Growth in Q225.  The 2-quarter average of Real GDP Growth, which cancels out this measurement problem, is 1.0% -- below the Fed's 1.7-2.0% estimate of long-term potential growth. 

The Unemployment Claims data are still diverging.  Initial Claims fell further in the latest week, while Continuing stayed high.  These data suggest that while companies have pulled back from firing workers, they are reluctant to hire.

 

CPI, Labor Market and Fed Monetary Policy

The stock market may trade cautiously as it moves into the corporate earnings season this week, with the softer macroeconomic background suggesting uneven reports (see the June 29 blog).  Moreover, tariff developments could keep the market on edge, as could Administration pressure on Fed Chair Powell to resign.  Nevertheless, there are reasons to be optimistic about the market.  Tuesday's June CPI Report could lift expectations of a Fed rate cut at the July 29-30 FOMC meeting.  A rate cut would likely still be a long shot, unless there is some pullback in announced tariffs.  Europe's decision not to retaliate at this point is encouraging that a trade deal will be reached before the August 1 deadline -- a market positive.  However, it remains to be seen whether this will be the case.

Consensus looks for +0.3% m/m for both June Total and Core CPI.  This would be a bit on the high side and not lift expectations of a near-term Fed rate hike.  A consensus or higher print would likely reflect some impact from tariffs.  Also, Airfares should not be as weak as in April and May, since seasonal factors turn neutral after depressing them in those months.  However, a lower print for Core can't be ruled out.  Owners' Equivalent Rent needs to stay low at 0.3%.  More generally, importers may have lowered prices to offset some of the tariff and maintain market share.  And, the subdued wage inflation in the US, as seen in the June Employment Report, could help hold down price increases.  

While a low CPI print could fan expectations of a near-term Fed rate cut, the latter is still probably a long shot.  The June FOMC Minutes indicated only a couple of participants considering a July easing.   Most of the FOMC members were focused on inflation risks stemming from tariffs.   And, Trump's latest spate of large tariff announcements could make these members even more concerned.

The latest Unemployment Claims data have mixed implications about the labor market, but are not likely to concern Fed officials.  Initial Claims remain below the June average for the third week in a row, suggesting a pullback in layoffs.  In contrast, Continuing Claims are still high, suggesting that companies are reluctant to hire.  Uncertainty about the impact of tariffs could be weighing on hiring decisions. 

Despite the divergence between Initial and Continuing Claims, if both stay at their latest respective levels for the next few weeks, they would point to a speedup in July Payrolls -- outside of government jobs, which could drop as state & local education jobs unwind their June jump and some of the Trump cuts in federal government jobs show up.  Although the July Employment Report will be released after the next FOMC Meeting, the current levels of both types of Claims are probably not high enough to change the Fed's view of a solid labor market.  

Looking ahead, the imposition of tariffs could have two, opposite impacts on the labor market.  Relocation of US production from abroad should boost demand for labor.  However, the drag on demand for goods and services from higher prices should depress it.  The latter could have the more immediate impact, since it takes time to shift production to the US.  Another major factor whose impact on labor demand is likely to increase over time is the substitution of AI for workers.  So far, there is anecdotal evidence that this is happening.  The negative impacts on the labor market from these two channels could result in Fed easing at some point.

Away from the economy, a possibly significant hit to the stock market would likely result if Trump succeeds in removing Powell from the Fed Chair.  The "manufactured" controversy over the Fed's new headquarters could be the catalyst.  With a new Trump appointee expected to be quicker to cut rates, longer Treasury yields should rise and the dollar fall.  The former, particularly, would hurt stocks.

  

 

 

 

 

 

 

 

 

 

 

 

Misleading Tariff Deadline (?) and June Employment Report

The stock market has to contend this week with the July 9th deadline for trade negotiations.  However, there are a couple of reasons why a pullback could be modest.  First, Trump has said this deadline is not set in stone.  And, the Administration will be sending letters to some countries threatening an August 1st implementation of high tariffs if there is no trade agreement in place by the deadline.  This threat could keep alive hope for a market-positive resolution in July.   Second, the June Employment Report in fact should sustain hope for a Fed easing that should continue to provide underlying support for the market.

Although the headline prints for the June Employment Report appeared to be strong and belie the need for Fed easing, the real story is that the Report was weak and argues for a rate cut.  The stronger-than-expected +147k m/m increase in Nonfarm Payrolls was lifted by a 73k jump in Government Jobs.  A bounce in State & Local jobs more than accounted for the latter, with education jobs mostly responsible.  There may have been a mismatch between seasonal factors and school-year end this month.  More importantly, Private Jobs slowed sharply to +74k from +137k in May.  At the same time, the Nonfarm Workweek fell to 34.2 Hours from 34.3 Hours.  As a result, Total Hours fell  0.3% m/m and are 0.5% (annualized) below the Q225 average -- a weak take-off point for Q325.

The dip in the Unemployment Rate to 4.1% from 4.2% also belies labor market strength.  The decline resulted from a drop in the Labor Force, as the Participation Rate fell.  Civilian Employment rose a modest 93k m/m.  A lower Labor Force Participation Rate could reflect discouragement about job opportunities.  Including Discouraged Workers, the Unemployment Rate was steady at 4.5%.

Wage inflation seems to confirm a softening labor market.  Average Hourly Earnings slowed to 0.2% m/m from their recent trend of 0.3%.  The slowing was fairly widespread, as more than half of the major sectors saw AHE equal to or below their Q225 average.  On a quarterly average basis, AHE is on a slow downtrend:

                                Average Hourly Earnings (quarterly average of m/m % changes)

                                               Q225        Q125        Q424        Q324 

                                                 0.27          0.30            0.37        0.40 

Despite the weak ending of Q225, it still looks like economic activity bounced noticeably on a q/q basis.  Total Hours Worked in Q225 rose 1.8% (q/q, saar) after +0.7% in Q125.  The bounce could be attributed to a return to trend after bad weather held economic activity down in Q125.  The Atlanta Fed Model's latest projections is 2.6% for Q225 Real GDP Growth.  Real GDP fell 0.5% in Q125.

Meanwhile, the Unemployment Claims data so far don't suggest the weak ending of Q225 is snowballing.  Claims appear to have stabilized during June.  So, sluggish economic growth in Q325, rather than recession, remains likely -- which would not stop a Fed easing at some point.