Ample Liquidity Outside of Real Estate Says No to Rate Cuts
After closing lower by -0.4% in immediate response to the widespread signs of tariff related price increases found in the July 15 release of June’s CPI, the S&P 500 subsequently advanced by 0.9% through July 17’s finish to a new record high. A richly valued equity, historically low compensation for corporate bond default risk, and a raging bull market in Bitcoin says there is absolutely no need for an end-of-July Fed rate cut. Financial markets effectively view the Administration’s call for an immediate -3.0 percentage point cut in fed funds as pure poppycock.
Inflation expectations and Treasury yields edge higher …
As inferred from the 5-year TIPS contract, the expected average annual rate of CPI inflation over the next five years rose from the 2.3% of late June to a now 2.5%. in response, the 10-year Treasury yield rose from 4.28% to 4.46%. Tariff policies and the President’s desire to control monetary policy may continue to put upward pressure on longer term Treasury bond yields.
After dipping to the 6.67% of the week-ended July 3, 2025, the FHLMC’s 30-year mortgage yield rose to 6.75% for the week-ended July 17.
To end the downward pressure now bearing on home prices, the 30-year mortgage rate’s benchmark 10-year Treasury yield may need to be no greater than 3.5%. Getting the 10-year Treasury down by a full percentage point from its recent close may be impossible without help from a disinflationary downshifting by domestic spending.
June’s retail sales suggest consumers may shoulder tariff-driven price hikes …
As inferred from June's 0.6% monthly advance by retail sales, June's real consumer spending probably grew by 0.3% monthly. Thus, after sinking from Q4 2024's unsustainably rapid 4.0% annualized quarterly increase to Q1 2025's 0.5%, real consumer spending probably improved to a below-trend 1.7% annualized growth rate from the first to the second quarter of 2025.
Retail sales’ year-over-year increase rose from Q1 2025’s 3.3% to Q2 2025’s 4.0%. However, the latter got a boost from the comparatively low 2.2% yearly rise by Q2 2024’s retail sales.
After excluding the price-inspired -5.5% yearly drop by gas station sales, the yearly growth rate for my version of core retail sales accelerated from Q1 2025’s 3.7% to Q2 2025’s 4.8%. The latter would have been slower were it not for core retail sales’ atypically subdued 2.3% annual rise of Q2 2024.
Five broad categories of retail sales grew faster than 5% year-on-year. They were the 8.4% of drug stores, the 6.4% of both non-stores (includes e-commerce) and restaurants, the 5.9% of home furnishing stores, and the 5.1% of motor vehicle and parts dealers. The needs and consumption preferences of an aging population help to explain the relatively rapid sales growth of drug stores and restaurants.
Even after including the rapid 5.9% sales increase of home furnishing stores, Q2 2025’s home-related retail sales eked out a yearly 0.6% gain as building material store sales fell by -0.6% yearly and home appliance & electronics store sales dipped by -0.2%.
For now, the collateral damage stemming from flat-to-lower home sales has been well contained. However, if home price deflation spreads and deepens, housing’s weakness will be more of a problem for the overall economy.
Dearth of jobless claims weighs against drop by domestic spending …
Yes, private sector jobs growth has slowed considerably. However, layoffs remain on the low side. For example, during the four weeks ended July 12, the average number of weekly jobless claims was off by -2% from a year ago. This was the deepest such yearly drop by initial state unemployment claims since the -3% of the four weeks ended August 31, 2024.
Decent retail sales weigh against impending drop by CPI inflation …
The consensus had been looking for monthly increases of 0.3% for June’s CPI both with and excluding food and energy prices. June’s headline CPI conformed to expectations and rose by 0.3%. In turn, the annual rate of CPI inflation jumped up from May’s 2.4% to June’s 2.7%, where the latter was a tad above the consensus view of 2.6%.
June’s 0.2% monthly rate of core CPI inflation lagged the consensus view, but June’s 2.9% annual rate of core CPI inflation matched the consensus’ call. Moreover, June’s annual rate of core CPI inflation eclipsed the 2.8% rate of the three prior months.
Early on, markets found some comfort in the slightly slower than anticipated monthly rate of core CPI inflation. However, unlike the markets’ blind indifference to June’s much lower than expected increase by private-sector payrolls that was made worse by the outright drop in private-sector jobs outside of healthcare, social assistance, leisure, and hospitality, markets focused on the details of June’s CPI report. And what upset investors was evidence of tariff-induced product price hikes.
Unless unit sales soften, tariff-induced inflation will get worse …
Among June’s most shocking tariff-related monthly price hikes were the 1.9% for home appliances, 1.8% for toys, and 1.4% for nonalcoholic beverages, sporting goods, computers, and household paper products.
June’s other monthly consumer price increases that were well above the 0.3% monthly rate of CPI inflation included the 2.0% of beef & veal, the 1.6% of both laundry & dry cleaning and pet services, the 1.2% of tools & hardware, the 1.1% for soups, chicken and property insurance, and the 1.0% for household furnishings & supplies and electric power.
Also, the Cleveland Fed’s median annual rate of CPI inflation jumped up from May 2025’s 2.7% to June’s 4.1%.
June’s monthly rise by the “super” core CPI lagged January 2025’s monthly jump …
June's unexpectedly small 0.2% monthly rise by the core CPI owed much to a 0.2% monthly rise by the roughly 44% of the core CPI consisting of shelter costs.
After excluding shelter costs in addition to the omission of food and energy costs, the monthly increase of the now "super" core CPI rises to 0.3%.
The latter was the biggest monthly increase by the "super" core CPI since January 2025's 0.5%.
The annualized rate of growth for the super core CPI has risen from the 2.2% of June 2024 through December 2024 to the 3.7% of December 2024 through June 2025.
After bottoming at the 1.8% of March-April 2025, the annual rate of "super" core CPI inflation subsequently rose to June's 2.2%.
More manufacturing production does not assure more manufacturing jobs …
The record suggests that trade policy efforts to boost US manufacturing production may prove disappointing in terms of new jobs added to factory payrolls. Notwithstanding an 18% cumulative advance by US manufacturing output from Q4 2001 to Q4 2007, the US’ number of manufacturing jobs still sank by a cumulative -13%.
From Q4 2019 to Q2 2025 manufacturing output barely rose by a cumulative 1.5% and manufacturing employment was unchanged.
According to Federal Reserve data, the moving 3-month average for manufacturing output peaked during the span-ended January 2008.
As derived from Bureau of Labor Statistics data, the moving 3-month average for the number of manufacturing jobs peaked during the span-ended July 1979.
From the peak of the 3-months ended July 1979 to the 3-months-ended June 2025, the number of factory jobs plunged by -34.7%. But that did not prevent an accompanying 99.1% increase by manufacturing output.
US’ last extended episode of 4% growth was joined by 12% import growth …
The last time US real GDP grew by at least 4% annually over a multiyear span was during the four years ended 2000. More specifically, US real GDP expanded by 4.4% annually, on average, during the years 1997 through 2000. Of special importance given the Trump administration’s obsession with the US trade deficit was how the US managed to grow faster than 4% for four consecutive years despite the accompanying 12.4% average annualized surge by the US’ real imports. The latter nearly doubled the accompanying 6.8% annualized growth of real exports.
In turn The US’ real trade deficit widened from 1996's -$69 billion real dollars to 2000’s -$410 billion real dollars.
Despite the span’s very rapid economic growth and partly because of the dramatic increase in competition from imports, the core PCE price index grew by merely 1.5% annualized, on average, during the four years ended 2000. A rate that was slower than its 2.3% average annualized increase during the contiguous four years ended 1996.
Accompanying a drop by the average US unemployment rate from 1996’s 5.4% to 2000’s 4.0%, the average annualized increase by the hourly wage of private-sector nonsupervisory personnel quickened from the 2.8% of the four years ended 1996 to the 3.9% of the four years ended 2000.
Now low jobless rate limits the upside for noninflationary growth …
A just released survey of Wall Street economists from SIFMA listed major areas of concern going forward. They are tariffs, the US government’s budget deficit, and labor market tightening. The latter implicitly recognizes the difficulty of sustaining a noninflationary rate of economic growth of 3% or faster if the economy is already operating close to full employment.
If noninflationary economic growth is already reined in by shortages of skilled labor, bringing the US up to 3% growth might necessarily require tolerance of faster price inflation and significantly higher interest rates. If the Fed cuts fed funds by -50 basis points amid faster economic growth and a declining unemployment rate, the 10-year Treasury yield just might rise by +60 basis points. The latter would make matters worse for a now struggling housing market and practically guarantee the spread and deepening of home price deflation.
Faster productivity growth can compensate for a shortage of workers …
A notable acceleration of labor productivity explains the slowing of core inflation amid faster wage growth. Labor productivity’s average annualized growth rate climbed up from the 1.0% during the four years ended 1996 to the 3.0% of the four years ended 2000.
The average annualized rate of productivity growth since 2001’s first quarter is 1.9%. Comparing the year-ended Q1 2025 with the year-ended Q1 2024 shows 2.2% productivity growth.
Supply-chain disruptions stemming from tariffs will weigh on productivity growth, while deregulation, the removal of uncertainty surrounding the tax treatment of capital outlays, and the introduction of artificial intelligence should boost productivity growth. Over time, technological progress tends to lift productivity and lower unit operating costs.