US economics, inflation, and the Fed
The U.S. economy returned to growth in the second quarter after contracting in the first, largely due to trade swings according to The Wall Street Journal (WSJ). The Commerce Department said U.S. gross domestic product — the value of all goods and services produced across the economy — rose at a seasonally and inflation adjusted 3.0% annual rate in the second quarter. The reading exceeded the 2.3% growth that economists surveyed by WSJ expected.
It followed a first quarter where GDP shrank at a 0.5% annual rate as businesses loaded up on imports to get ahead of the Trump administration’s anticipated tariffs. Over the first six months of the year, the economy grew, but at a much more modest pace than last year: at a 1.2% annual rate. That was slower than 2.5% growth in 2024, measured from the fourth quarter of the prior year. The economy has grappled this year with stop-start tariff policies, a nosedive and partial recovery in consumer sentiment and worker deportations.
The impact of the Trump Administration tariffs on prices for goods has yet to meaningfully materialize according to Value Line. On point, the Producer Price Index (PPI) was unchanged in June. The benign PPI reading is noteworthy, as it is used to calculate the Personal Consumption Expenditures (PCE) Price Index, which is the assessment of inflation most closely tracked by the Federal Reserve. That said, the Consumer Price Index (CPI) came in slightly hotter than expected in June, and most economists feel that the true effect of the tariffs, which will include additional duties on August 1st, will be seen in the current quarter. General Motors reported a $1.1 billion impact from tariffs on its June-quarter profits.
Meanwhile, second-quarter earnings season got off to a good start, led by strong profit growth from the big money center banks. Shortly thereafter, the average earnings growth forecast for the S&P 500 companies was ratcheted up, to around 6%. Value Line states that with the economy recovering in the second quarter and the tariffs not yet having as big of a negative impact as one would have expected in early April, profit growth will easily exceed expectations. In general, many of the big businesses were able to absorb the extra costs to avoid significantly raising prices and risk losing customers.
Global economy
Global activity readings have been stronger than expected over the past three months. JP Morgan (JPM) forecasts a 2.2% annual rate of global GDP gain — up a full percentage point in the second quarter of 2025. This week’s July survey readings signal upside risks to JPM’s forecast for growth to slow to a 1.2% annual rate this quarter. Recent growth resiliency has been faded as a more drawn-out path to tariff hikes defers a growth drag and promotes continued front-loading of goods sector activity. But the April recession risk was partly associated with the threat of a concentrated shock magnified by a sentiment slide. Several factors have unfolded more constructively than expected and warrant a baseline view in which a recession is avoided:
- Sentiment and financial conditions are disconnected. Tariffs are a tax hike on US purchases of foreign goods, but this tax drag is not likely to be large enough to derail the US expansion. However, JPM has expressed concern that this drag would be magnified by a slide in US and global business sentiment. A broad drop in business sentiment has, in fact, materialized. Indeed, July flash PMI output expectations remain depressed, and the US all-industry capex intentions are still mired in recession territory. However, the slide in business sentiment has not been reflected in financial conditions, which have eased materially. Despite Governor Waller’s argument that the Fed stance is restrictive, its model-based estimates of monetary transmission point to a positive impulse over the coming four quarters.
- Speed kills: April tariffs were not implemented immediately as delays and exemptions have slowed the rise and the pass-through to US consumer prices. Meanwhile, onerous China tariff hikes that threatened to disrupt supply chains were reversed. While a significant shock remains in the pipeline, these developments have reduced the risk of a more concentrated or disruptive growth drag.
- It’s not a war when only one side fights. The primary trade war drag is anticipated to come from US tariff hikes, but we also look for some retaliation. Retaliation has not materialized outside China and Canada, and some barriers to US exports have been lowered. There remains uncertainty around the implementation of trade barrier reductions and the implied extension required through most favored nation status requirements. But an expected rise in global trade restrictions has turned into a modest step toward opening markets for the US.
JPM’s assessment of risk has evolved, but the bank still sees a significant downshift in US and global growth during the second half of 2025, projecting the global economy to expand by 2.3% by the year end.
Stock market
While the earning season is in full bloom, Professor Siegel recently commented on the market developments:
“The market has come to terms with this dynamic and continues to look ahead to more powerful, longer-term forces, particularly the ongoing AI. I think the market rightly assesses this will buoy productivity and earnings. In particular, the immediate expensing provision for capital equipment that came in the ‘One Big Beautiful Bill’ is a meaningful tailwind for corporate investment, counteracting some negative tariff effects…
Importantly, earnings season is not showing signs of a breakdown. While there is some cautious forward guidance, the tone has been far more constructive than feared. I’m encouraged by year-end earnings estimates, which remain stable or even modestly positive. I continue to believe we are in a healthy bull market with no signs of internal deterioration…
From a valuation perspective, some argue markets are expensive. When measuring forward P/E ratios, we are increasingly pricing in next year’s earnings, which are supported by strong productivity trends and expanding technology adoption. The 2025–2026 EPS outlook is solid, and while earnings might come down from lofty year ahead outlooks, I continue to see upside in equities.”
The information and opinions included in this document are for background purposes only, are not intended to be full or complete, and should not be viewed as an indication of future results. The information sources used in this letter are: WSJ.com, Jeremy Siegel, Ph.D. (Jeremysiegel.com), Goldman Sachs, J.P. Morgan, Empirical Research Partners, Value Line, BlackRock, Ned Davis Research, First Trust, Citi research, HSBC, and Nuveen.
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