Core CPI came in softer than expected for the 5th straight month: 0.2%, month over month (MoM) and 2.9% year over year (YoY). The YoY number did tick up slightly given the low comp rolling off from last year (monthly numbers shown on graphic below).
Headline CPI came in line with consensus at 0.3% MoM and 2.7% YoY. Some pockets reflect price increases within goods, likely due to tariff pass-through (furniture, appliances, electronics). Given an uptick in June/July tariff revenue, it is something to monitor, both regarding pressure on prices as well as consumer appetite to accept higher prices.
We’ll be looking for upcoming earnings commentary to see the extent companies plan to use price increases as a way to pad margins in how they deal with impending tariff costs. On a positive note, continued softening in shelter, car insurance, and airfares is helping alleviate service pressures that have been problematic in the last several years. Tariff-related inflation hasn’t materialized as feared yet, although time will tell whether tariff pressures do indeed create problems in the back half of the year.
Looking Forward
Economists’ worst-case expectations see a full tariff pass-through adding 1% to the CPI, which would make it pretty hard for the Fed to cut rates. In fact, even if only half of those tariff effects appeared, we would expect the central bank to extend its policy pause until (at least) December.
By then, if monthly price inflation has settled back down, the Fed could deliver a cut. Ultimately, there are big disagreements within the Fed about 1) how much inflation will appear, 2) how persistent it will be, and 3) whether it warrants a monetary response. We see rate policy over the 2H of 2025 playing out based predominantly on three outcomes:
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- Tariffs add more than 0.5% to the CPI, the labor market remains solid, and the Fed postpones its next rate cut until December (cutting only gradually thereafter)
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- Tariffs add less than 0.5% to inflation, the Fed cuts gradually from September
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- Labor market cracks –inflation fears thrown aside – Fed cuts quicker than consensus is expecting.
Now, given a July cut is very unlikely given recent data, we wait for Jackson Hole in August for greater clarity on where Fed consensus stands, after getting a few more months of data and impact from tariffs.
Long End Rates Marching Higher
While interest rates have pushed higher, specifically on the long end, the US has been one of the least impacted. Long-term rates have pushed higher globally, specifically in Japan and Europe (Germany), steepening yield curves.
There has been much talk on Trump, Fed issues (Trump wanting to fire Powell), fiscal dominance, etc., but other countries are facing even more pressure on their long duration bonds than we are. Whether it’s the German fiscal package (significant increase in defense spend) announced earlier this year, or Japan finally coming off the 0% floor, it seems investors are somewhat desensitized to the US fiscal situation. Rates here in the US are still hovering in their past 2-year range and appear unproblematic to both risk assets and credit.
Credit Spreads Say No Problems!
Equity and credit risk premiums have continued to compress since the April market lows, as the labor market remains robust and hard data stays resilient. The optimist’s view of growth this year is that the data YTD has been heavily distorted by Trump’s policy swings. It appears markets are dismissing any negative data as “pre-TACO” (Trump Always Chickens Out).
Tight credit spreads continue to reflect a healthy financial backdrop and economy. Given spreads are tight, the additional cushion for investors in high yield is small.
High yield investors typically make outsized returns after credit spreads widen drastically, which provides another layer of defensibility against credit issues/defaults. While we are happy to see credit firm as a positive sign for the economy, we don’t love the reward-to-risk ratio from here.
More Problems for Bond Holders
Bond investors continue to face a difficult backdrop. Limited correlation benefit from bonds relative to stocks (positive correlation) and a stubborn backdrop of elevated interest rates and a steepening yield curve.
Bond term premiums remain structurally elevated given that hedging properties of bonds remain lackluster. Additionally, uncertainty around the future path of Fed policy continues to be high, fiscal concerns are unlikely to dissipate anytime soon, deflation is no longer a concern for the Fed, and foreign investors appear to be (at least on the edges) diversifying core US fixed-income holdings with other alternatives (other sovereign bonds, gold, etc.).
More stocks/less bonds/risk neutral will always be the Aptus story (and we’re sticking to it) as we see traditional bonds as certificates of confiscation in real (after-tax/after-inflation) terms. If the liquidity number goes up, the number (stocks) goes up. Based on the OBBB (One, Big, Beautiful Bill) deficit projections, it’s apparent the liquidity number will continue to “go up”.
Quick Check on the Consumer
US JUNE RETAIL SALES RISE 0.6% M/M; EST. +0.1%
Retail sales came in much stronger than expected, showing a broad advance in most categories (10 of 13 categories posted increases). This report will temper some of the concerns that the consumer is weakening. Broadly, it shows some relief to the (unfounded) anxiety around the health of the consumer. While Americans might be pessimistic about tariff impact, the report shows they are still spending.
Disclosures
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