The sun burst shining through the clouds this week, as the financial markets received a massive dose of clarity. President Trump’s One Big Beautiful Bill was signed into law – meeting his Fourth of July deadline. Moreover, he announced a trade deal with Vietnam – the nation with the fastest rising US trade deficit, thanks to China factory relocations and transshipment. The better-than-expected employment report put the Federal Reserve back on the sideline, at least for the July meeting. Data from the PMIs and ISMs showed economic activity in the rear-view mirror had been cautious – but with price pressures still significant. The more recent unemployment claims data indicate firms were trimming around the edges, as they awaited the clarity that just broke through. The markets’ reaction has been to push the S&P500 to a new record high – in dollars – but foreign investors remain cautious, despite higher US rates after the jobs report. OPEC added to optimism over the long weekend, indicating they would increase production again beginning in August.
We believe the combination of clarity, fiscal stimulus at home and abroad, and less concern about energy will lift US second half growth after the first half pause – much as we rebounded from the early 2022 malaise (caused by concern about higher interest rates) after Biden’s Inflation Reduction Act picked the fiscal winners for that Administration. This is hardly a bold call, given that investors are already clamoring to fund new growth. However, as noted, the S&P is still cheaper for foreign investors, with prices about 10% lower than the previous high, at least in euros. We still read the weakening of the dollar in recent months as a move to the top of the trading range rather than a breakout – which would come at 1.20 dollars to the euro. A firmer Fed outlook and better H2 US growth should maintain the range.
President Trump indicated that many tariff letters will be going out on Monday – with rates as high as 70%. However, given the recent agreements with the UK and Vietnam, we believe he has bracketed the tariffs that will finally prevail in a 10% to 20% range, with punishment for China at 30%. Some smaller trade partners may still be singled out, but we see the newest round of letters as pressure to accelerate negotiations – oh, and collect some revenue in the meantime. Global trade representatives know that the UK ran a trade deficit with the US, and agreed to a 10% baseline. They know Vietnam was one of the largest trade abusers, and got 20%, in return for untariffed access to Vietnam’s rapidly growing economy, $2 trillion in commitments for US energy and agriculture (a drop in the bucket), and a 40% penalty on transshipped Chinese goods. What Chinese content is counted as transshipped is unclear, suggesting some Chinese exporters will try and game the system for 20%, as opposed to 30% — risking 40%, and likely additional penalties.
We expect many nations would be happy to get Vietnam’s terms, and will press for fast agreements once they have received letters for even higher rates. With the USMCA agreement to be renegotiated in 2026; a preliminary agreement with China at 30%; and Vietnam and the UK done – the Big Kahuna now is the EU. They are offering 10%, but with carveouts for pharmaceutics, semiconductors and autos (pretty much all that really matters.) Japan wants a similar deal, but Trump is taking a harder line on autos. Will all their factories end up in the UK or Vietnam if deals cannot be struck? We continue to believe that trade uncertainty will retreat in the second half as Trump presses forward. The Fourth of July deadline for the budget was seen as unrealistic – but it was achieved. Just as when Trump asked for – and received – a 21% corporate rate rather than the widely touted 25%. Our view is investors should not bet against his success.
Long time readers know that my optimism about the US economy’s ongoing success is not an approval of President Trump’s current policies. We do not believe tariffs are an efficient way to raise taxes or influence trade, nor will his border policies improve labor markets for domestic workers. However, given our view that the US sits at the top of the global economic pyramid – and that it is nearly impossible to have a recession in the US without greater pain elsewhere in the world – we do not see these policies causing a US recession, or close to it. Rather, we believe they will slow growth from its recent torrid 2.8% pace, yet allow inflation to remain higher than the Fed’s 2% target – perhaps revisiting 4% over the next year. We expect slower growth still means above potential (1.9%), and that higher inflation will not cause the Fed to raise rates, or lead the market to believe they will. Bottom line, we see the new Trump policies as a modest drag on a resilient US economy, and fear of budget deficits and inflation as longer run concerns that will be offset in the present by the effects of fiscal stimulus – in the US and abroad.
While we see continued success for the aggregate US economy, that does not mean a rising tide will raise all boats. The imposition of tariffs and immigration reforms will be burdensome to some sectors – especially goods producing and distributing – and fall more heavily on small businesses. Meanwhile, deregulation will be easier to exploit for big businesses, who can benefit from scale. The ability of big business to adopt rapidly deflating artificial intelligence options as an alternative to domestic labor or capital goods investment also argues for ongoing concentration in wealth and income in America – and indeed the world. That concentration is self-reinforcing as faster growth for corporate profits than for GDP means big firms can afford to snap up the best young competitors – or their strategies.
For us, the biggest question is how much nominal growth is slowing in the US – and which sectors will remain strongest as the weak are crowded out by slower top line growth. The US economy maintained a growth rate around 5% from 2023 Q4 through 2024, but plunged to 3.2% in 2025 Q1 before rebounding in the second quarter. Measures which ignore trade and inventories, like final sales to domestic purchasers, have remained more stable for longer. As noted in recent missives, compensation has outperformed asset-based income and small business returns in recent months – suggesting to us that higher income households have been absorbing the brunt of the Trump policy uncertainty. The rebound in equity values suggests they are now more confident. Meanwhile, a moderation in hiring and a slower pace of wage growth also suggest that they have begun sharing more of the slowdown with the working class.
With the results in on employment and wages for June, our income proxy (hours x wages) rose at a 5.1% annual rate in the second quarter, rebounding from 4.3% in the first. The first quarter was soft due to both weather and a robust 6.3% gain in the fourth quarter. However, extrapolating the recent six-month average on wages (3.4% annualized) and employment growth (1.0%) through September generates just a 4.1% gain in the income proxy. This outcome, and our view that immigration reform will cool population driven growth by at least 0.5%, leads to concern that nominal growth may be slowing – effectively tightening monetary policy and offsetting some of the fiscal stimulus.
We have argued that with overnight rates and the ten-year note both well below the 5% nominal GDP growth rate, monetary policy was not restrictive. Indeed, it appears to us that the federal government has been borrowing money and distributing it to corporations (via Biden’s IRA and Trump’s low corporate tax rates) effectively borrowing on their behalf at a lower interest rate than they would get from markets or banks. That provides a stimulative impulse to the economy and financial markets. Indeed, households and businesses have been able to build historically strong balance sheets at the same time analysts wail about the long-term consequences of government debt. Narrower spreads between corporate and government rates reflect the improved position of one relative to the other. The fact that government rates are now higher relative to GDP than in the past is a consequence of them having become the economy’s key borrower.
The question is whether the pause in business investment early in 2025 was temporary or more long lasting. We lean toward the view that businesses paused due to uncertainty – and will rebound in the second half, and into 2026, due to the extension of business expensing options. That suggests a pick up in bank lending, faster money growth, and a rebound in nominal growth. In that circumstance, the Fed would stay on hold, as inflation rises from firms passing through some of the tariffs (or just because everyone else is raising prices, so why not them?) Given the markets current upbeat mood, we expect them to read that rebound in nominal growth as supportive –even if it keeps the Fed on hold. After all, faster inflation generally is good for profits as it lifts revenues with no cost, fattening margins.
Even if growth has slowed to a steady low 4%-handle in nominal terms, investor confidence is likely to remain strong as Fed easings would become far more likely. That figure in the third quarter would suggest either a return to slower growth, with sustained 2.7% inflation – or a drop in inflation toward the target with still moderate growth. Either would likely lead the Fed to trim rates in September. Even a surge in tariff related inflation, which would stall real growth as prices exceeded wages, would likely be viewed as temporary if more deals were being done in the 10% to 20% range. Bottom line, with so much uncertainty just erased, it will take a new shock to derail the current equity upswing.
Economists excel at extrapolating current economic imperfections into cycle ending recession scenarios, but the invisible hand has been increasingly effective at evading those downturns – at least for the US at the top of the economic pyramid. The latest crisis that threatened economic Armageddon was the end of the Trump tax cuts – which few in the markets ever expected would happen. The solution was to pay for the tax cuts with tariffs, cuts in Medicaid, and more borrowing. The major consequence has been an erosion in the dollar. This is precisely the agenda Trump was elected on in 2018, but was derailed by Covid. The delay allowed the invisible hand plenty of time to prepare.
The most egregious policy error pre-Trump was quantitative easing, which artificially held interest rates down – long and short – taxing interest earners to the benefit of borrowers, including the government. Trump, who likes leverage, never addressed this – but Covid, money drops and inflation killed QE and returned rates to a more market driven level. The long run result of QE is a housing market dominated by 3% thirty-year mortgages, which strengthen homeowner balance sheets as they pay down quickly, but make new access to housing and mobility major issues. Among small investors, this made equities more attractive than real estate. The shift to equities helped attract foreign capital, strengthening the dollar even more, to the benefit of the top of the US wealth ladder. The rise in wealth sparked greater risk taking, culminating in the AI race, which holds the potential for greater productivity — meaning more output, less work, more leisure.
Time has also allowed a more elegant solution to the Trump tax shift – as he always planned to cut US corporate rates and pay for it with tariffs, primarily on China. China agreed to 10% tariffs and other Phase One demands in 2018, but again Covid derailed much of that process. Rather, the global shutdown everywhere but China (excluding Wuhan) resulted in a booming Chinese global trade surplus. China exploited their efficiencies generated through concentration and clustering to dominate new technologies, like electric vehicles and semiconductors, dampening their domestic crisis in real estate. They also used their ballooning global trade surplus to buy influence which will help them adjust – through capital redeployment into the Global South – to new 30% tariffs. We expect the top end of China’s economy to be fine. As in the US, wealth creation has provided a buffer to economic shocks – especially those signaled long ago.
For us the most interesting outcome of the tax/tariff twist is in how foreigners are absorbing their share of the pain. Economic theory tells us that tariffs are shared between domestic buyers and foreign producers, depending on the elasticity (flexibility in demand relative to price changes). Typically, that leads the exporter to weaken their currency, so revenues remain steady in their home currency after tariffs. All their workers, even those not in export industries, are paid less in international buying power. They import inflation, which helps demand shift to domestic alternatives.
In this cycle, foreign currencies were already weak due to domestic issues (Ukraine war, energy, Chinese real estate). Rather than weaken currencies to support exports, foreign capital has been returning to home base to invest in domestic industries which offer better potential returns – strengthening their currencies relative to the dollar. Their workers gain international buying power, while the US imports deflation to offset the higher tariffs. The greatest burden is borne by international investors who hold their wealth in dollars – effectively giving back a small part of the huge bull run.
Moreover, in the US, more than 50% of all consumption is by the top 10% — so tariffs are being absorbed by those most able to pay higher prices. Yes, the mix of goods and services means less than 50% of tariffed goods are bought by the top, but it is still close – considering a hefty part of low-end income goes to untariffed rent or mortgage payments. Also, higher income households own the businesses which are paying US compensation, which is growing faster than their asset-based income.
Bottom line, the invisible hands reallocations in the currency markets signal that international trade is not top of mind for many profit-maximizing investors. Domestic stimulus has attracted capital home, with little pressure from exporters to devalue – likely because everyone already had during Covid and its aftermath. Thus, the pain is being absorbed more by capital markets than consumers, which bodes well for global economic stability as tariff rates are set.