Macro
This week’s data offered a mixed picture for the U.S. economy. The July ISM Services index came in below expectations, with the employment component sinking further into contraction territory while the prices index climbed to its highest level since October 2022. The NY Fed’s Survey of Consumer Expectations showed inflation expectations moving higher, with the 1-year outlook up 10 bps to 3.0% and the 5-year up 30 bps to 2.9%. Initial jobless claims came in slightly weaker than forecast, and continuing claims rose to their highest since November 2021.
These readings have brought stagflation concerns back into focus as the effects of Trump’s tariff measures begin to filter through the economy. Inflation risks are re-emerging ahead of next week’s closely watched July CPI release, even as headline macro data still suggests resilience. Strategists warn that slowing growth, sticky inflation pressures, and greater data volatility could complicate the outlook. Tariff-related price increases are already visible in goods such as furniture and bananas, and broad-based measures, along with upcoming sector-specific tariffs, are likely to add further complexity. Durable goods prices have also turned higher after months of declines, reinforcing upward price pressure. The University of Michigan survey now points to 4.5% inflation expectations for 2026. The Logistics Manager Index fell from 60.7 to 58.2 in July. Initial jobless claims edged up from 219 K to 226 K, while continuing claims rose from 1.94 M to 1.97 M.
New analysis indicates that foreign exporters are absorbing a larger share of recent U.S. tariff costs than in the 2018–2019 trade war. Import prices for tariffed goods declined modestly through June, suggesting exporters reduced their prices to maintain competitiveness. Empirical estimates indicate roughly 14% of total tariff costs have been absorbed abroad so far, potentially rising to 25% if recent tariffs follow earlier patterns. This partial passthrough has softened but not offset price pressures for U.S. consumers. If the effective tariff rate rises by a projected 14 percentage points in 2025, import prices could fall about 3.5%, mitigating part of the inflation impulse but leaving domestic prices still elevated due to margin rebuilding and supply frictions.
The Fed’s policy path remains uncertain. While some expect the central bank to hold steady until more evidence accumulates, a sharper economic slowdown could prompt a quicker response. The so-called Fed put is viewed as less reliable than in past cycles, and elevated Treasury yields are making investors more cautious toward longer-duration assets.
A separate issue now drawing policy attention is the reliability of economic data itself. Central bankers and analysts have raised concerns about increased measurement noise following President Trump’s dismissal of the BLS commissioner. Weaker survey response rates, post-pandemic volatility, and underfunded statistical agencies have widened the range of potential revisions. While the overall deterioration appears modest, it has increased the uncertainty around near-term policy calibration. Model simulations suggest that if data noise were to rise by 40%, central-bank responsiveness could fall by half, potentially delaying rate moves or prompting policy errors with measurable GDP costs.
Rates
On Thursday, Treasury yields moved higher across the curve after a lukewarm auction. The 10-year rose 9 bps to 4.24%, the 2-year gained 6 bps to 3.73%, and the 30-year added 2 bps to 4.82%. Open interest has been rising across maturities, with the 10-year holding above 4.25% despite signs of labour-market softness. Weak demand at recent auctions has kept yields elevated, and near-term moves could hinge on incoming data and changes at the Fed.
As the revised payrolls report showed just 14,000 adds in June and 19,000 adds in May, with adds mostly in healthcare and net job losses elsewhere, the three-month average gain fell to about 35,000. That slowdown has strengthened expectations for a September rate cut, particularly if August’s figures also disappoint. San Francisco Fed President Mary Daly said rate reductions will likely be needed soon, citing easing core inflation (excluding tariff effects) and a cooling labour market. Minneapolis Fed President Neel Kashkari echoed that the economy is slowing and may soon warrant policy adjustment.
Political uncertainty is also shaping the outlook. Chris Waller is reportedly the leading contender to replace Chair Powell. However, the White House is said to be considering about ten candidates, including former St. Louis Fed President James Bullard. Meanwhile, Trump has nominated CEA Chair Stephen Miran to fill the Board seat vacated by Governor Kugler. If confirmed before the September meeting, Miran could shift the Fed’s balance sheet more dovishly and increase dissent risk if Powell opposes a rate cut.
Futures now price in over a 90% probability of a September cut, up from 37% before the payrolls release, and roughly 57 bps of easing by year-end versus about 40 bps previously. Alongside dovish Fed commentary, sentiment has been supported by clarity on certain tariff carveouts, oil price weakness, solid corporate earnings surprises, a wave of buyback announcements as the blackout period ends, and continued momentum in the AI growth narrative.
Market-based inflation expectations underscore this tension. The swap market prices a peak inflation rate of 3.4% in May 2026, then a glide to 3.0% two years out. One-year inflation swaps are near 3.4%, two-year near 2.9%, and five-year near 2.67%. ISM Prices Paid remains an input here, keeping term premia uneasy. Over the next year, the 10-year is likely to reprice with the inflation path; for now, it is rangebound and still above 4.2%, with trade noise and data volatility sustaining choppy yields even if expectations steady.
Ongoing policy uncertainty is being amplified by noisier data and tariff effects, raising the Fed’s risk-management premium around each print. With one more weak jobs report or a benign 0.2–0.3% core CPI, markets could entertain a larger first move, and a 50 bp “catch-up” cut cannot be ruled out. Committee dynamics may get choppier if Stephen Miran is seated before September, heightening the risk of dissent if the chair resists cutting.
Still, several headwinds remain. Stagflation fears resurfaced after cautious inflation data and softer surveys, while tariff impacts are expected to intensify into the second half of the year. Inflation expectations have been drifting higher, consumer signals are weakening, and heavy Treasury issuance, highlighted by three disappointing auctions and a record $100 billion four-week bill sale, has kept a floor under rates.
Portfolio managers warn that overweight cash and underweight duration could prove costly if easing accelerates. Money market balances are elevated, but reinvestment risk is rising. Intermediate Treasuries offer attractive real yields near 2% and nominal yields around 4%; tax-equivalent municipal bonds exceed 6%; and specific mortgage-backed securities yield close to 5.5%, levels appealing to investors looking to lock in income ahead of potential rate cuts. Interview colour supports this expression: conventional agency MBS around 5.5% coupons still screen attractive for carry and duration, especially as lower-tier consumer trends soften and a “no-hire, no-fire” tone emerges. The bigger tactical risk may be sitting in cash as cuts begin, given elevated money-market balances and rising reinvestment risk.
Credit
Fannie Mae and Freddie Mac could soon return to public markets, with potential IPOs valued at up to $500B pending congressional approval. Such a move could have a meaningful impact on mortgage rates and housing finance dynamics. In anticipation, some investors are extending duration in the mortgage-backed securities space, viewing current valuations as attractive and expecting policy initiatives aimed at reducing housing costs. Agency MBS with 5.5% coupons continue to screen appealing for long-term investors, offering carry opportunities as policymakers push to normalise the housing market.
Primary credit markets remain active. U.S. investment-grade issuance reached about $40B this week, marking the busiest period in over three months, while high-yield volumes climbed to roughly $11B, the strongest since January. Spreads are still trading near historic tights despite macroeconomic uncertainties, supported by solid technical factors: roughly $15B in high-yield ETF inflows over the past 15 weeks, steady coupon income, and an overall higher-quality issuer base. Notably, most high-yield transactions have been refinancing-driven, which has kept default risk contained. The short average duration of the high-yield universe, near three years, also cushions spreads and helps explain the market’s resilience.
Managers continue to emphasise credit selection, as the Q2 earnings season has delivered a clear divergence. Most companies exceeded expectations, but those that missed saw sharp repricing. Fundamentals are back in focus, with investors more concerned about avoiding idiosyncratic losers than chasing marginal yield. The consumer picture is similarly mixed. While overall spending has held up, lower-income households are showing signs of strain under elevated prices. Corporate commentary from major consumer names suggests trading-down behaviour and softer traffic, consistent with a “no-hire, no-fire” labour market that limits income growth and could temper consumption into year-end.
Globally, the recent weakening of the U.S. dollar has reinvigorated interest in international credit markets, particularly in hard-currency issues from Latin America. With the exception of Mexico, much of the region has limited tariff exposure to the U.S., offering some insulation from trade-related headwinds. A softer dollar also eases repayment conditions for non-U.S. borrowers, drawing renewed cross-border flows into investment-grade euro and emerging-market debt.
Looking ahead, issuance is expected to ease seasonally into Labour Day, but activity could rebound later in the year as M&A-related financing and potential private equity transactions add fresh supply. Strategic acquisitions announced in recent weeks are already setting up funding pipelines for Q4, suggesting that true new-risk supply could replace the recent wave of refinancing as the next theme in primary markets.
Equities
After a brief pullback last week, U.S. equities resumed their upward momentum, extending a strong 28% rally from the April lows. The S&P 500 has gained about 8% year-to-date, but performance dispersion across the market remains unusually wide. While the index is within 1% of its record high, the median S&P 500 stock is still roughly 12% below its 52-week peak. Investors have leaned into select themes such as AI, large caps, and industrials, while avoiding small caps and defensive sectors. August’s thin liquidity and the absence of a Fed decision until September have kept trading in a cautious, “wait-and-see” mode, yet the tone remains constructive. The Dow rose 1.4%, the S&P 500 gained 2.4%, and the Nasdaq advanced 3.8%.
Sector performance reflected renewed risk appetite. Consumer Staples (+3.65%), Technology (+2.11%), Materials (+1.61%), and Communication Services (+1.60%) led the advance, while Energy (-2.74%) and Financials (-1.06%) lagged. Other sectors saw more modest changes. Market leadership remains narrowly concentrated in high-growth areas, while smaller, more defensive names have struggled to keep pace.
This divergence has pushed equity return dispersion to extreme levels. The three-month dispersion among S&P 500 constituents has reached 36 percentage points, ranking in the 82nd percentile over the past 30 years and sitting above the 70th percentile in 9 of 11 sectors. Investors’ preference for quality companies with strong balance sheets and high margins has driven valuations to stretched levels. The top 20% of S&P 500 stocks by quality now trade at a 57% P/E premium to the lowest-quality group, close to the highest spread since 1995. Historically, when this premium has exceeded 40%, forward 12-month outperformance has been capped at around 10%, suggesting limited upside and a potential for rotation if growth proves more resilient than expected.
Earnings season continues to confirm corporate resilience. With about 90% of S&P 500 companies now reported, blended earnings growth stands at 11.8%, well above the 4.9% expected at the start of the season. Revenue growth reached 6.6%, and 81% of companies beat both EPS and sales estimates, exceeding recent averages. Earnings surprises have averaged 8.4%, stronger than the one-year average of 6.3% but slightly below the five-year norm of 9.1%. Market reactions have been asymmetric, with beats rewarded less and misses punished more sharply.
Recent trading highlighted these contrasts. AI-related momentum stayed strong (PLTR +21.2%), while GLP-1 uncertainty weighed on healthcare (LLY -17.9%) and a more competitive AI hardware environment pressured semis (SMCI -21.3%). Discretionary demand softened (CROX -22.5%, SG -18.4%), and tariff headwinds dragged on consumer names (ELF -12.6%, UAA -17.2%). Travel and leisure names diverged (EXPE +9.7%, ABNB -5.5%).
Corporate news remained active. Apple posted its best week since 2020 after announcing a $100 billion investment in U.S. manufacturing that secured partial relief from chip tariffs. Tesla rose 8.9% after its board approved a $30 billion incentive plan for CEO Elon Musk. Reports of potential GSE IPOs lifted FNMA and FMCC by double digits.
Beyond company-level developments, the debate on data quality and policy responsiveness has gained attention. Based on Federal Reserve research, central banks have historically exercised appropriate discretion when responding to noisy data. Still, model estimates indicate that if data volatility were to rise by 40%, policy responsiveness could fall by about 50%. In practice, that means central banks might react more slowly to data surprises unless they are confirmed by broader evidence. Even a small policy mistake, such as an unnecessary rate hike or a delayed cut, could reduce GDP by 0.1% over two years, a cost greater than the annual budget of most statistical agencies. Cross-country comparisons also show that weaker data quality tends to coincide with lower currency valuations and slower financial sector development, underscoring the role of credible statistics in supporting market confidence and growth.
Overall, while seasonal factors and tariff uncertainties may cause short-term volatility, the broader environment remains supportive. Strong earnings, a patient Federal Reserve, and the potential for sector rotation beyond mega-cap technology continue to underpin sentiment. With the S&P 500 near record highs and strategists targeting 6,600 by year-end, the market bias remains upward, even as elevated valuations and data uncertainty call for selectivity and disciplined positioning.