The Macro Backdrop

Geo-Alpha

Liberation Day seems like a lifetime ago. But the 90-day pause is almost over, and—thus far—there are few deals that have been consummated. The countdown to July 9—the deadline for trade deals—is on, and markets will be particularly keen to see who makes a deal and what those deals entail. Rumors abound about the countries that are close to coming to terms with the Trump administration, but rumors do not sign the paper. That is the primary risk facing markets, that—much like Liberation Day—there are negative surprises on the horizon for the conclusion of the negotiation period. Certainly, exemptions and exceptions will happen, and some trading partners are going to come out the other side with a positive relationship and economic outlook. The questions outstanding are who and to what extent. And the answers are critical to understanding global asset market dynamics for the remainder of 2025 and 2026.

The “One Big Beautiful Bill” made its way through D.C. There are numerous elements to the bill that warrant attention. But the evolution of the State and Local Tax deduction (SALT) is acutely important. The provision for up to $40,000 is critical for consumers—a significant tailwind to middle- and upper-middle-income consumers. SALT is widely harangued as being a benefit to “blue states,” but “red states” will benefit as well (evidenced by the New York Congressional Republicans backing the SALT language). There are also provisions allowing businesses to 100% expense Research and Development costs, providing a potential boost to innovation in the future.

Taken together, there are positives and negatives coming from the combination of trade and tax deals. It will be important to understand who and what benefits from them, and whether or not they are meaningful to markets. Trade deals will be crucial to understanding the future of shifting global supply chains, and the OBBB will be fundamental to understanding the trajectory of the U.S. economy. Neither should be ignored.

“Trade deals will be crucial to understanding the future of shifting global supply chains, and the OBBB will be fundamental to understanding the trajectory of the US economy.”

Avoiding a Recession

The U.S. economy got off to an inauspicious start to the year, at least from a formal statistical perspective. Indeed, the Bureau of Economic Analysis reported that Q1 real GDP contracted by a modest -0.5%. This disappointing performance gave rise to concerns that a “textbook recession,” or two consecutive quarters of negative real GDP, could be in the offing.

Although “Liberation Day” hadn’t even occurred yet, the January–March data was impacted by tariff-related developments, at least from a trade perspective. Specifically, a surge in pre-tariff imports overwhelmed other positive components of the GDP report, resulting in the negative outcome. Interestingly, underlying demand, consumption and investment were visibly on the plus side of the equation.

That was in the past; where do we go from here? Based on available data, it looks like the import surge was reversed in Q2, and we can get back into positive territory. With labor market activity remaining relatively solid, the underpinnings exist for the U.S. economy to potentially avoid any policy-related pratfalls that could be coming on the tariff front in the second half of the year. In fact, the focus could very well shift to any potential stimulus that could occur as a result of the passage of the “One Big Beautiful Bill.”

Against this backdrop, we maintain as a base case that a recession can be avoided but fully acknowledge that the probability of an economic downturn has not gone away completely. However, on the “other side of the trade,” the markets are not priced at all for a scenario where growth surprises to the upside.

“We maintain as a base case that a recession can be avoided but fully acknowledge that the probabilities for an economic downturn have not gone away completely.”

Inflation: Will Disinflation Be Short-Lived?

The latest inflation readings have no doubt underscored that disinflation appeared to be a prominent trend in the second quarter. The cooling of price pressures from the goods side of the equation had been expected, for the most part. A more interesting and perhaps more important development has been that services-related inflation has finally shown some easing.

Indeed, in our opinion, shelter-related costs in reports, such as the Consumer Price Index (CPI), had been overstated for quite some time, and we have been anticipating some lessening here, impacting the overall services component, accordingly. Going forward, investors should potentially expect basically the opposite of the inflation trends outlined above. In other words, any tariff-related price increases would be more likely to show up in the goods sector of the economy, while services could be more neutral on overall inflation trends.

The potential challenge going forward will be to see if the markets can look through any tariff-induced increases to inflation and focus instead on underlying demand pressures. In addition, as Fed Chair Powell recently stated, another key factor to consider is whether any potential increase in prices will be short-lived or have more of a persistent impact.

Either way, the Fed’s 2% target continues to be elusive.

“The potential challenge going forward will be to see if the markets can look through any tariff-induced increases to inflation and focus instead on underlying demand pressures.”

Fed Policy: In No Hurry

As expected, the Fed did not make any changes on the rate front at the June FOMC meeting. The policy maker did tweak its outlook in both the policy statement and updated Summary of Economic Projections (SEP). Within the policy statement, the voting members adjusted their language by now saying that “uncertainty has diminished” versus “has increased further.” With respect to their economic/inflation forecasts, real GDP growth was dialed back a bit, while inflation was dialed up a bit. The closely followed dot plot remained at two rate cuts for this year, but the 2026 outlook was downshifted from two decreases to basically just one.

Powell & Co. continue to reiterate that monetary policy is “well positioned.” However, the chairman’s comments seem to focus more on the inflation aspect of their dual mandate as he maintains that labor market conditions “remain solid.” In other words, the Fed is in no hurry to cut rates.

Bottom line: The macro setting allows the voting members to take a deliberate approach to monetary policy. In other words, the song remains the same, i.e., the Fed is data-dependent and can let the data “come to them.” Against this backdrop, a reasonable-case scenario still involves potentially one to two rate cuts this year.

“The Fed is in no hurry to cut rates, maintaining that monetary policy is ‘well positioned’ and focused on inflation over labor market concerns.”