Mark Vitner

Labor Market: Cracks Beneath the Surface

June’s nonfarm payrolls rose by 147,000, with modest upward revisions to April and May. The unemployment rate edged down to 4.1%, but the internals tell a different story. Hiring was concentrated in healthcare, education, and government. Employers have added an average of 150,000 jobs a month for the past three months, with most of that gain coming from healthcare, leisure and hospitality, and state and local government. Separately, the ADP employment measure reported a loss of 33,000 private-sector jobs during June, its first decline in 27 months—driven by a 47,000 drop at firms with fewer than 50 employees.

Even the slower growing nonfarm payroll numbers likely overstate job growth. As we’ve noted repeatedly, the QCEW data, which reflect a count of jobs from unemployment insurance tax rolls, suggest job gains have likely been overstated by around 900,000 jobs. We will get updated data through March 2025 (which is the preliminary source material used for the annual revisions) on September 9, three weeks ahead of the September FOMC Meeting.  Another variable to watch is federal employment, which fell again in June and is down 69,000 since January. More declines are likely as retirements pick up, allowing attrition to further reduces staff levels.

The May JOLTS report showed job openings rising to 7.77 million, but 80% of the gain came from accommodation and food services—likely a seasonal blip or possibly a response to tightening immigration enforcement. Hiring dipped, layoffs remain low and the quits rate remains subdued. With the unemployment rate at 4.1%, it’s hard to argue the labor market is unbalanced—but momentum is clearly fading, as seen in the narrowing breadth of job gains, rising level of continuing claims and dwindling share of consumers stating that jobs are plentiful.

Slowing immigration is weighing on labor force growth and restraining the unemployment rate.

ISM: Stabilization Without Strength

The ISM Services index edged back into expansion at 50.8, while ISM Manufacturing remained just barely in contraction at 49.0. New orders softened to 46.4, while employment fell further to 45.0, with manufacturers trimming staff to cut costs amid margin compression from rising input costs, tepid final demand and tariff-related uncertainty. Production ticked up, but new order backlogs fell, and hiring remains on hold.

The ISM indices are consistent with slower economic growth but not a recession. The Manufacturing Index would need to dip below 43.7 to be consistent with a downturn.  Still, the soft recent readings are another sign the economy is losing momentum.

Housing and Nonresidential Construction Weaken

Construction spending declined for the ninth straight month in May. Residential investment is now tracking an 7% annualized decline for Q2, driven by weakness in single-family construction and hesitancy among potential homebuyers. Nonresidential structures are also faltering, with business investment in structures on track to decline at a 5.5% pace in Q2. Data center construction is a bright spot, but factory and power structure investment is retreating, particularly for plants requiring foreign-produced machinery. The tax bill’s levy on China-linked solar and wind projects may further depress green infrastructure spending.

Trade and Tariffs: Trump’s Revenue Engine

President Trump announced a tariff agreement with Vietnam, reducing U.S. duties from 46% to 20% in exchange for duty-free access for American exports. Goods transshipped through Vietnam—primarily from China—will face a 40% tariff. This follows earlier bilateral deals with China and the U.K.

Vietnam maintains the third largest trade deficit with the U.S. and has become an important destination for manufacturing operations moving out of China due to trade or costs concerns, particularly for shoes, furniture and consumer electronics The 40% tariff goods routed through Vietnam is likely a signal of where Chinese tariffs are ultimately headed, particularly for transshipped products, regardless of which country they are routed through.

Fiscal Dominance and the Dollar

President Trump signed the expanded “One Big Beautiful Bill” into law, potentially increasing annual deficits to $3.3 trillion annually by 2035. The package relies on optimistic scoring and a Treasury pivot to short-term debt issuance. We feel the CBO is underestimating the positive impacts from the budget bill but still see extremely large deficits for as far as the eye can see. Trump is openly pressuring the Fed to lower rates to contain borrowing costs—a potential shift toward fiscal dominance.

Trump continues to pressure Powell to cut rates to spur growth and lower financing cost.

“Fiscal dominance” refers to a regime in which the central bank subordinates monetary policy to fiscal needs, effectively monetizing debt to keep government borrowing costs manageable. It’s not just about buying bonds—it is about the Fed losing the ability to fight inflation independently, cornered by the size of the deficit and rising interest payments.

We are not there yet, but the risks are no longer merely theoretical. The newly signed spending bill adds to an already unsustainable fiscal trajectory, and markets are questioning how long the Fed can keep monetary and fiscal policy in separate lanes. The weakness in the dollar, strength in gold and crypto are all warning signs about the unsustainability of fiscal policy.

Still, today’s Fed is far more independent than in the past—and far less likely to monetize debt outright. The greater risk may be the opposite: that the Fed will delay rate cuts simply to avoid the appearance of political capitulation. That would be a policy error. Inflation is clearly easing, PCE is near 2%, inflation expectations remain anchored or are becoming more so, and the real economy is slowing. Employment growth is narrowing, housing is stagnant, and business investment is losing steam.

In that context, the Fed should cut rates by 75 basis points, starting at the July FOMC meeting. September is more likely—but every delay increases the risk of overtightening into a slowdown already unfolding both above and beneath the surface.

The 1970s taught us what happens when monetary policy caves to political pressure. But that era also reminds us how quickly confidence-driven mistakes can become structural ones—especially when the Fed hesitates at the wrong moment.

Despite surging deficits, bond yields have been volatile, and the dollar has dropped nearly 11% year-to-date. Treasury auctions this week will once again test market demand amid growing concerns about foreign participation.

Mamdani and the Message from New York

Zohran Mamdani’s Democratic primary win in New York highlights rising discontent with establishment economic policy. Mamdani’s socialist platform has drawn comparisons to 1970s India, while his foreign policy stances have drawn criticism for anti-Israel and antisemitic rhetoric. Still, his rise reflects a deeper concern: the economy no longer works for many Americans. The share of national income going to wages has been declining for decades, a trend exacerbated by the rise of China and the erosion of U.S. manufacturing employment.

Both the far right and far left are gaining traction by focusing on pocketbook issues long ignored by the political center—even if many of their proposed solutions are economically incoherent or politically untenable. The underlying sentiment, however, is not to be dismissed: frustration with inequality, affordability, and economic insecurity is driving a new wave of political realignment. The two major political parties should focus on finding practical and meaningful solutions.

Israel: Escalation Avoided, Fragile Progress Continues

President Trump’s Monday meeting with Israeli Prime Minister Benjamin Netanyahu comes as the region shifts from confrontation to cautious diplomacy. A 60-day pause in Gaza fighting is underway, and indirect ceasefire talks between Israel and Hamas have resumed. Iran, weakened by Israel’s systematic destruction of its proxy network and then highly effective U.S. and Israeli airstrikes against its air defenses and nuclear infrastructure, has signaled openness to restarting nuclear negotiations, and the White House has opened quiet channels with Syria’s new government.

Trump hopes to leverage these developments into a broader diplomatic breakthrough—including an expanded Abraham Accords framework. Beyond Saudi Arabia, the administration is exploring the possibility of drawing in Syria and even Lebanon. While politically complex, such moves represent the most ambitious extension of the accords to date.

Meanwhile, an unprecedented initiative in Hebron could test a bottom-up model of Israeli-Palestinian diplomacy. Sheikh Wadee’ al-Jaabari and four other leading tribal figures have signed a letter recognizing Israel as a Jewish state and proposing the formation of an independent Emirate of Hebron. Their plan calls for joining the Abraham Accords, establishing a joint economic zone, and replacing the Oslo-era Palestinian Authority with clan-based leadership grounded in local legitimacy.

The initiative pledges “zero tolerance” for terrorism and outlines a phased labor partnership with Israel. It has been quietly supported by Economy Minister Nir Barkat and has drawn attention from both U.S. and Saudi officials. With the backing of clan leaders representing over 500,000 Hebron-area residents, the proposal could serve as a test case for a decentralized, pragmatic approach to governance. While the sheikhs’ plan represents a sharp departure from the stagnant Oslo framework, its success will depend on both political will and regional coordination.

A broader Middle East peace deal would have substantial carry through to other parts of the globe and would be a positive for global financial markets and U.S. leadership. Russia and China have used the Middle East conflict to tie the U.S. up and weaken support throughout developing countries. Without this wedge, more progress will be possible elsewhere.

Volatility Retreats, But Uncertainty Lingers

Despite economic crosscurrents, global business and financial markets do not appear overly anxious. Business sentiment surveys show muted concern, and the market-implied probability of severe outcomes (like a U.S. recession or a 20% drop in equities) has declined. Implied volatility in currency markets has also fallen, providing some stability following a long slide in the value of the dollar. Treasury yields have also fallen back off their recent highs, despite heightened concerns about persistent large budget deficits. Expectations for Fed rate cuts have also increased, with the markets currently pricing in between 3 and 4 quarter point cuts by the middle of next year, with kickoff coming in September.

Looking Ahead: Week of July 8–12

• NFIB Small Business Optimism (Tuesday, July 8): We are looking for a modest rise in the NFIB index, as easing geopolitical pressures and recent financial market stability boost expectations.
• Tariff Deadline (Wednesday, July 9): President Trump is expected to send ‘letters’ to countries without finalized deals. Watch for additional announcements on BRICS-aligned penalties.
• FOMC Minutes (Wednesday, July 9): Look for confirmation of the Fed’s cautious tone and insight into members’ views on tariffs and labor slack.
• Jobless Claims (Thursday, July 10): Jobless claims remain exceptionally low going into a seasonally volatile period for claims that could see initial claims move lower. Continued claims, however, continue to trend higher, reflecting a tougher market for job seekers.
• Treasury Auctions: 3-, 10-, and 30-year bond sales may test market tolerance for ballooning debt.

Final Thought: A Delicate Balance

Markets may be rallying, but the fundamentals are drifting. Hiring is slowing, margins are compressed, the Fed remains boxed in, and global trade rebalancing is still underway. Yet geopolitical risks have eased—at least temporarily—and fiscal stimulus is flowing. The second half of 2025 will be a test of execution. The pieces are now coming into place such that a modest, well-timed interest rate cut could set the stage for a resurgence in growth next year. Policymakers must stay disciplined until the inflation threat fully recedes.

Beneath the Resilience, a Slowing Core

Economic data for the week offered a mixed view: on the surface, business investment and durable goods orders showed surprising strength, but underlying demand is softer than earlier thought and many key measures are flashing warning signals.

Real consumer spending was flat in May, with a downward revision to April. The details were more concerning: services spending fell outright, and goods spending gains came from volatile durables, not essentials. Real disposable income is running below 2% year-over-year, even as the savings rate edges higher — a sign tariffs and broader geopolitical, fiscal and labor market risks weighed on consumer behavior this past spring.

After pulling big-ticket purchases forward ahead of tariffs, consumer spending has moderated.

Consumer sentiment rebounded in June, following six consecutive months of declines. The index was revised higher to 60.7, up 8.5 points or 16% from May, as easing tariff pressures, falling energy prices and rebounding share prices bolstered household finances. Notably, high-income households reported the largest improvement in buying conditions for durable goods. Moreover, the absence of a tariff-induced price surge is improving consumer psyche. Year-ahead inflation expectations fell to 5.0% — still elevated but down significantly from May’s 6.6%.

Pending home sales rebounded in May but only partially offset April’s decline. Mortgage rates hovered near 7%, and affordability challenges continue to weigh on demand, especially in the resale market. New home sales also fell, dropping 13.7% to a 623,000-unit pace — the slowest since October 2024 — despite generous builder incentives.

The slowdown in home buying is rebalancing the housing market, with sellers now outnumbering buyers in many areas. Existing home inventory has risen to a 4.4-month supply, while new home inventory has climbed to 9.8 months at May’s pace. This added supply is pressuring prices: the median existing home price is up just 1.7% year-over-year, and new home prices, though higher in May, are down 1.9% on a three-month average.

A surge in commercial aircraft orders sent factory orders soaring in May.

Durable goods orders surged 16.4% in May, the largest increase in over a decade, driven almost entirely by a 230% spike in commercial aircraft following a major Boeing deal with Qatar. Excluding transportation, orders rose a more modest 0.5%, with broad-based gains led by computers, electrical equipment, and fabricated metals. Core capital goods shipments — the key input for GDP business investment — also rose 0.5%, raising expectations for Q2 growth.

Revised GDP data revealed that Q1 growth was even weaker than previously reported. Headline growth was downgraded to a -0.5% annualized pace, as downward revisions to consumer spending and inventories outweighed a modest upside in net exports. More importantly, real final sales to domestic purchasers — a key gauge of underlying demand — rose just 1.9%, the slowest pace in over two years. Nonetheless, our internal tracking model still estimates Q2 GDP growth at 3.8%, supported by resilient consumer spending and business investment in capital equipment.

Awaiting Clarity on the Labor Market and Inflation

Powell reiterated in his congressional testimony that the Fed is “well positioned to wait.” The June SEP projections imply two cuts in 2025, but the dot plot reflects a wider divergence in view. September remains the most likely time for the next Fed move.

The labor market continues to lose momentum. While initial jobless claims declined modestly in the latest week, continuing claims — a better gauge of trend softness — rose again, hitting the highest level since November 2021. The rise in continuing claims suggest job seekers are having a harder time landing a new job and matches the climb in the share of consumers stating that jobs are hard to get in the Conference Board’s Consumer Confidence survey.

Inflation continues to cooperate. May’s PCE deflator and core PCE deflator came in close to expectations. While inflation remains above the Fed’s 2% target, the trend is moving in the right direction, particularly for problematic areas like core services’ prices.

Precision Strikes, Summits, and Shifting Alignments

The past two weeks marked one of the most consequential periods in global security since the Cold War. Israel launched a coordinated campaign against Iran’s nuclear infrastructure — including the Fordow and Esfahan enrichment sites — in response to what it determined was an “imminent” threat. The United States played a decisive supporting role, deploying B-2 bombers and submarine-launched cruise missiles to finish the job and neutralize deeply hardened targets. The IAEA has confirmed that Fordow’s centrifuges are “no longer operational.”

While Israeli forces led the majority of the strikes, U.S. capabilities were instrumental in penetrating Iran’s fortified facilities. The use of overwhelming force has significantly delayed — and possibly neutralized — Iran’s near-term nuclear breakout potential. Still, uncertainty lingers over whether Tehran managed to relocate any enriched uranium or advanced centrifuges in advance of the strikes. Recent intelligence casts doubt on those claims, and Israel’s targeting of military leadership, nuclear scientists and Iran’s classified nuclear archive will make any restart more costly, complex, and time-consuming.

Back in Washington, public debate focused more on language than results. The strikes’ effectiveness became a political flashpoint, as critics questioned terminology (such as the meaning of obliterated) rather than impact. In reality, Operation Midnight Hammer was a tactical and geopolitical success — the product of operational discipline, deliberate deception, and precision targeting. In an age of leaks, the mission’s secrecy underscored the professionalism of those involved and restored confidence in the Pentagon’s ability to deliver under pressure.

The political implications are equally significant. The operation’s success shifted the landscape, which is likely the driving pushback from outlets historically critical of the administration. While some coverage attempted to reframe the strikes through a partisan lens, the result was unambiguous: the White House delivered on its 60-day ultimatum, and the Pentagon executed with precision and resolve, dispelling lingering doubts about American credibility that had persisted since the failed Afghanistan withdrawal.

A ceasefire between Israel and Iran was announced shortly after the operation concluded. Though early hours saw sporadic retaliatory fire, President Trump moved quickly to deescalate. In a widely reported moment before boarding Marine One en route to the NATO summit, Trump dropped the “F-bomb” in pointed and targeted way before the press. Trump’s use of profanity is rare and deliberate—something he notes in Trump: The Art of the Deal, strategic disruption can be an effective negotiating tool. In this case, the expletive underscored the urgency of de-escalation, sent a clear message to both allies and adversaries, and ultimately helped lock in the ceasefire.

At the NATO summit in The Hague, Trump translated that momentum into broader geopolitical capital. All but one alliance member — Spain — committed to raising defense spending to 5% of GDP over the next decade. It marked a break from post–Cold War norms and reasserted NATO’s relevance in a more volatile multipolar world. Trump’s blend of hard-power diplomacy and political theater resonated, resetting the alliance’s deterrence posture in real time. Trump’s reception at the summit was, by far, the best that he has seen as president.

Meanwhile, the Abraham Accords are regaining momentum. U.S. and Israeli officials have signaled that Saudi Arabia and Syria may be open to joining as part of a broader regional stabilization framework. Proposals are under discussion for temporary Arab League oversight of Gaza and the release of remaining hostages. Trump and Netanyahu are reportedly aligned on a phased ceasefire and long-term political settlement. In a region long defined by deadlock, this moment represents rare forward movement — and the window for action may not remain open for long.

On the trade front, the U.S. and China reached a limited trade agreement late last week, ironing out the details of the Geneva agreement reached to earlier in the month. In addition to a partial rollback of tariffs and renewed Chinese commitments to purchase U.S. agricultural and energy exports, the agreement includes critical provisions on rare-earth minerals. China agreed to resume and expedite rare-earth exports to the U.S., addressing a key bottleneck in supply chains essential for electric vehicles, defense systems, and semiconductors. The deal removes a major overhang for U.S.-based EV and battery manufacturing projects, many of which had stalled due to input shortages and uncertainty around equipment sourcing. While the agreement remains narrow in scope, it serves as a strategic reset—intended to stabilize trade flows, support industrial investment, and ease bilateral tensions ahead of broader negotiations later this summer.

Political Capital Meets Legislative Headwinds

Despite recent geopolitical victories, including the Iran ceasefire and NATO defense pledges, progress on President Trump’s reconciliation package has run into some additional resistance from budget hawks in the Senate. While the administration originally targeted passage before the July 4 holiday, the president has since acknowledged that the timeline is flexible and that negotiations may extend into mid-July.

The most significant development came last week when the Senate parliamentarian ruled that several Medicaid-related provisions — projected to generate roughly $600 billion in savings — violated reconciliation rules. Proposals to cap provider taxes and tighten eligibility standards were deemed noncompliant with the Byrd Rule, which prohibits policy provisions lacking a direct budgetary impact. The ruling forced Senate Republicans to revise the bill’s fiscal framework, removing key offsets and increasing pressure to pare back the legislation’s scope.

While party leaders remain optimistic about passage, the final package is now expected to focus on more politically viable components, including extending the lower tax rates from the 2017 tax bill, some modest tax reforms, energy permitting, and trade enforcement measures. Broader entitlement reforms are likely to be deferred to future legislation.

Headed into the Second Half of the Year

The first half of 2025 has been marked by rapid and consequential shifts on both economic and geopolitical fronts. One theme has emerged with unmistakable clarity: the reassertion of U.S. leadership. From brokering an end to the India–Pakistan conflict to coordinating precision strikes on Iran’s nuclear infrastructure and halting the 12-Day War, the White House has reestablished its strategic presence. A reinvigorated NATO defense posture and renewed momentum behind the Abraham Accords have further reshaped the global security landscape.

Meanwhile, the U.S. economy has navigated a complicated mix of disinflation, softening consumer demand, and intensifying policy debates over trade, tariffs, and fiscal strategy. From the battlefield to the bond market, the first half of the year was defined by disruption, recalibration, and strategic signaling. After early volatility, markets appear to be adjusting to a faster, more forceful pace of change.

As the second half begins, attention will likely turn from disruption to execution. The challenge now lies in translating bold strategic moves into durable outcomes—whether through stabilizing trade relations with China, securing passage of a restructured fiscal package, or reinforcing fragile geopolitical agreements. Institutional resilience, rather than headline momentum, will define this next phase. Financial markets will look for policy follow-through in an environment of cooling growth and rising policy complexity. We continue to expect two rate cuts from the Federal Reserve, with the first likely in September. The path forward may be less volatile, but will demand discipline, coordination, and an ability to manage through this new rapid tempo without making a policy misstep.

Looking Ahead: Week of July 3, 2025

• Chicago Business Barometer (June) – Monday, June 30:
  A quiet start to the week, with the Chicago PMI as the sole release. While regional, the index offers an early read on manufacturing sentiment heading from a manufacturing intensive area in a holiday-shortened but consequential week.
• ISM Manufacturing Index (June), JOLTS (May), Construction Spending (May) – Tuesday, July 1:
  Manufacturing continues to hold its ground amid tariff disruptions. Lean inventories and strong backlogs should keep the ISM index in the high 40s—above the 43.7 level typically associated with recession.

JOLTS job openings will be closely watched. Rising continuing claims and a decline in the share of consumers saying jobs are plentiful suggest growing friction for job seekers.

Construction spending likely declined in May, as residential and commercial activity softened. Data centers remain a key area of strength, but tariffs on Chinese equipment are delaying major manufacturing projects.

• ADP Employment Report (June) – Wednesday, July 2:
  ADP payrolls have shown more weakness than the official jobs report, though they may better align with revised BLS data over time. We expect another soft print, though some upward revision to the prior month wouldn’t be surprising.
• Employment Situation Report (June), ISM Services (June), U.S. Trade Balance (May), Initial Jobless Claims – Thursday, July 3:
  Nonfarm job growth has averaged 135,000 over the past three months, driven by healthcare, hospitality, and local government. We estimate true underlying job growth is closer to 100,000 and are forecasting a 115,000 gain in June. Seasonal noise tied to the school calendar and summer hiring may lead to downside volatility.

ISM Services is expected to rebound modestly, pushing the index back above the key 50 break-even threshold.

Trade data and jobless claims will round out a dense morning of macro releases.

• Geopolitical Watch:
  The Big Beautiful Bill could pass the Senate early this week, though reconciliation with the House remains. Final passage is likely by mid-July, with key changes expected on healthcare offsets and fiscal scope.

Inflation: Unexpectedly Cooling

May’s CPI and PPI prints once again surprised on the soft side—headline and core CPI rose +0.1% m/m; and the headline PPI matched that pace, with core goods prices declining. Businesses are apparently absorbing tariffs or deferring their impact by relying on previously source goods, especially in new motor vehicles and apparel. The core CPI has risen at just a 1.7% annualized pace over three months, while falling energy prices and smaller price hikes at the grocery store have held the overall CPI to just a 1% pace. This has allowed real wages to eke out modest gains, supporting consumer spending.

Tariffs are not proving to be as terrifying, as inflation continues to run below expectations.

Inflation fears appear overblown. While tariffs will eventually raise prices on select imports, they also reduce consumers’ discretionary spending power—limiting broader inflationary spillover. With roughly two-thirds of household spending concentrated in domestic services, any tariff-driven rise in goods prices is likely to be offset by disinflation in categories such as travel, dining, and recreation. The net effect is a dampened pass-through to overall inflation, opening the door for a rate cut.

Nearly every measure of inflation is moderating faster than expected, including measures of core services, which were problematic a year ago.

Consumer sentiment improved in early June, with the preliminary University of Michigan index rising to 60.5 from 52.2. The rebound, which broke a five-month downtrend, appears tied to the recent easing of U.S.–China tariff tensions, lower gasoline prices, easing grocery prices, and a resilient labor market.

All five of the survey’s components increased, with current conditions rising 4.8 points and expectations climbing 10.5. Encouragingly, the sentiment recovery was broad-based—cutting across income, geography, and political affiliation. The improvement in expectations is notable, as they are most closely tied to actual spending and had been severely depressed.

Consumer sentiment improved broadly in early June, while inflation expectations declined.

Year-ahead inflation expectations fell 1.5 percentage points to 5.1%, and long-run expectations edged lower to 4.1%, signaling some tentative improvement in inflation psychology. The retreat in expectations was overdue and came alongside equity market gains and another round of surprisingly benign inflation reports. The lack of a resurgence in inflation tied to tariffs reduces the risk that consumers will pull back spending preemptively. The data also preceded Israel’s attack on Iran’s nuclear facilities and defense infrastructure.

Business Sentiment: Cautious Stabilization

NFIB small business optimism rose to 98.8 in May—its first increase in six months—as sales expectations improved. Owners remain frustrated by the lack of progress on tax and regulatory relief and are struggling to absorb tariff-related cost increases. Capital spending plans are muted, with policy uncertainty delaying investment. Survey results align with ISM and factory orders data showing flat demand and persistently weak exports.

Labor Market: Cooling, Not Cracking

Initial jobless claims held at 248,000 for the week ending June 7, while the four-week average rose to 240,250—its highest since August 2023. Continued claims climbed to 1.956 million, the most since late 2021. While some of the increase may reflect seasonal transitions, the broader trend points to a softening labor market.

Federal employee claims remain below February highs, but signs of structural slack are emerging. The long-term unemployed share is rising, and surveys signal slower hiring amid tariff uncertainty. Layoffs remain low, yet job postings are down and reemployment is taking longer—pointing to growing friction. Still, conditions remain stable enough for the Fed to prioritize inflation control, though risks now tilt toward further labor market weakening.

Trade Outlook: Pause, Not Peace

The U.S.–China trade deal capped U.S. tariffs at 55%, China’s at 10%, and introduced a temporary rare-earth export agreement. The deal is tentative and allows companies to apply for a six-month license to purchase rare earths and magnets. While this removes some downside risk—a final settlement remains far off. GDP forecasts for 2025 have increased slightly. Our latest forecast, released Tuesday, calls for 3.8% growth in Q2, following by 1.4% growth in the second half of the year. For the year as a whole, we see real GDP rising 1.7% on a Q4/Q4 basis.

Recent Treasury auction data show mixed demand: the June 10-year note auction cleared at 4.45%, with soft indirect demand, pointing to market caution amid elevated supply. Meanwhile, the May Monthly Treasury Statement showed a $316 billion deficit—better than last year’s $347 billion—but fiscal year-to-date deficit widened 13.5% versus FY2024 thanks to a torrent of spending late last year and in early 2025.  Rising entitlement costs, defense spending, and elevated interest payments remain structural headwinds.

Tariff revenue, now expected to contribute $2.5 trillion over the decade, provides some cushion and comes close to covering the CBO-project revenue loss from the GOP-led One Big Beautiful Bill’s tax cuts and spending hikes.

Geopolitical Risk: Rising Lion and Global Fallout

Israel launched a major military campaign—Operation Rising Lion—striking upwards of 100 Iranian nuclear and military sites, including Natanz and Isfahan. The strikes killed IRGC Commander Hossein Salami and senior commanders Mohammad Bagheri and Amir Ali Hajizadeh. Iran responded by launching 100 drones, which were largely intercepted by Israeli defenses.

New intelligence suggests the Israeli campaign included covert drone strikes, launched within Iran, on ballistic missile launchers and a decapitation operation targeting senior military leadership. Confirmed airstrikes included high-value targets such as the Natanz Enrichment Complex, Kermanshah underground missile storage, and key sites in Tehran and Esfahan. Much of Iran’s military leadership was eliminated in highly targeted strikes. Iran’s immediate response was muted—analysts believe Israel’s disruption of missile infrastructure and the deaths of key military leadership delayed a coordinated counterstrike. Iran has since launched missile barrages, most of which have been intercepted.

Iranian Supreme Leader Khamenei vowed retaliation but offered no specifics. Meanwhile, Tehran has suspended nuclear negotiations and may escalate its regional posture through proxies like the Houthis and Hezbollah. Israel apparently has free reign over Iranian skies and is openly refueling fighter bombers in clear daylight. Nuclear facilities are likely to be hit repeatedly in order to destroy the hardened bunkers they reside in. Israel has said the operation could last for up to two weeks and the objective is to eliminate the nuclear program—not set it back.

A frustrated and defeated Iran may lash out at its population, which was openly feeding information to Israel via the internet before Iranian authorities worked to shut down internet access. Iran might also strike neighboring oil facilities. Oil markets reacted with a 7–8% spike, and safe-haven demand surged for Treasuries and the dollar. Oil prices are still lower than they were a few months ago.

G-7 leaders, set to meet in Kananaskis, Alberta, Canada from June 15 to 17, 2025, are expected to confront a crowded agenda. Discussions will likely span artificial intelligence, global economic imbalances, defense partnerships, and regional stability—including the Israel–Iran conflict and support for Ukraine. The setting—a return to the Canadian Rockies where the 2002 summit was held—underscores the gravity of the moment. Hosted by Canadian Prime Minister Mark Carney, this 51st summit will also welcome key invitees including Ukraine’s President Zelenskyy, along with leaders from Australia, South Korea, India, Brazil, and Saudi Arabia. Coordination—or lack thereof—will shape market risk sentiment as the G-7 grapples with an increasingly fractured global order.

Recalibrating Risks

Inflation trends and the volatile policy environment support the Fed’s pause. The labor market is cooling, however, and the balance of risks is shifting as inflation repeatedly undershoots expectations and jobless claims edge higher. Tariff and tax uncertainty continue to weigh on investment and hiring.

The Israel–Iran conflict has recalibrated global risks. Treasuries, the dollar and gold are drawing safe-haven demand. The G-7 and FOMC meetings will serve as key diplomatic and economic inflection points to incorporate shifting geopolitical and economic risks. Israel has stated that it is planning a 14-Day operation to eliminate the Iranian nuclear program. Merely setting the program back would be a failure and increased global risks.

Markets will be watching for any shift in diplomatic posture toward Israel and Iran, as well as how the Fed recalibrates the inflationary risks from tariffs and higher energy prices against the disinflationary pressures of slowing growth.

Looking Ahead: Week of June 17, 2025

• FOMC Meeting (June 17–18): Expect the Fed to hold rates steady, but all eyes are on forward guidance and risk assessments. Market focus will be on Powell’s tone amid mixed macro data, slower inflation and elevated geopolitical risks.
• Retail Sales (May): Tuesday’s Retail Sales report will help further shape expectations for Q2 growth. Look for a rebound in discretionary purchases, which jumped in March ahead of tariffs and fell back in April.
• Housing Starts and Permits (May): Homebuilders face demand headwinds from rising insurance premiums and lingering affordability challenges. New home inventories have been rising, and builders have been cutting prices to spur sales. We expect another soft reading for both single- and multifamily starts.
• G-7 Summit (June 15–17, Kananaskis): Leaders from the G-7 and invited nations will tackle AI governance, support for Ukraine, Middle East volatility, global trade, and defense collaboration. Specific attention will be paid to China’s economic coercion, USMCA renewal prospects, and the economic governance gap between the G-7 and BRICS.
• Geopolitical Watch: Iran’s response to Israeli strikes—and whether proxies such as the Houthis or Hezbollah can coordinate retaliatory attacks—remains a key geopolitical risk. Any G-7 coordination on sanctions or diplomatic overtures could meaningfully shift global risks but not until Israel destroys much or all of Iran’s nuclear infrastructure.
• Treasury Refunding Outlook: Watch for potential updates on long-duration issuance plans and bond market reactions to persistent deficit concerns.

The May employment report showed the labor market is losing momentum and raised hopes that the Fed will cut rates a little sooner and by a little more than was expected earlier. Nonfarm payrolls rose by 139,000 in May—slightly below the 12-month average—and downward revisions shaved 95,000 jobs off the previous March and April estimates. Job growth remains concentrated in a narrow range of industries, with health care and hospitality accounting for the bulk of job gains.

Federal payrolls tumbled by 22,000 in May and are down 59,000 year to date. That is a sharp contrast with expectations, particularly given that court rulings have paused formal layoffs. The pullback is driven by attrition and an ongoing hiring freeze, as well as some catch up in the data for jobs cut earlier. We look for larger declines in federal payrolls during the second half of this year, as agencies do not replace retiring staff.

Real private domestic sales offer a clearer view of underlying economic momentum.

While the unemployment rate was unchanged, the household survey was weaker than that headline would suggest. The labor force participation rate fell 0.2 points, and the employment-population ratio fell 0.3 points. Prime-age participation also slipped, suggesting some job seekers may have left the work force. Tightening immigration is also likely playing a role. The employment data are volatile, but the weakening trend is becoming harder to dismiss. Jobless claims have climbed in recent weeks, and the four-week moving average now stands at its highest level since October.

Tariffs Are Increasing Costs and Reducing Demand

Tariff-related distortions continue to ripple through the economy, obscuring signals and intensifying uncertainty across supply chains. The April trade report revealed a collapse in goods imports—the sharpest monthly decline since the pandemic—with particularly steep drops in pharmaceuticals, gold, and motor vehicles. Imports from China alone have fallen 40% year to date, in response to tariff rates that exceeded 100% in April before being modestly scaled back. That dramatic import pullback sharply reduced the U.S. trade deficit, providing a temporary lift to Q2 GDP through a narrower trade deficit. The Atlanta Fed GDPNow forecast for Q2 is currently at 3.8%. The underlying details tell a less encouraging story: final sales to private domestic purchasers have softened, and investment in equipment and structures is losing momentum.

Businesses are increasingly absorbing cost pressures at the margin, wary of passing along price increases in a political environment where “inflation” remains a flashpoint. With tariff-related costs mounting, particularly in sectors reliant on imported components or finished goods, many firms are turning inward to preserve margins. That means spending cuts, headcount reductions, and deferred investment. The most immediate response has come in the form of hiring freezes, reduced hours, and selective layoffs, as noted in the latest Beige Book and ISM surveys.

Retailers and manufacturers are reporting narrower margins and declining order volumes. The reluctance to raise prices stems less from competition than from consumer resistance, political scrutiny, and the risk of drawing unwanted attention—potentially even a presidential callout. With inflation expectations rising and actual inflation slowing, businesses are caught between rising input costs and softening demand, with no straightforward way to pass costs along.

The strain is particularly evident in durable goods. Light vehicle sales fell to a 15.6 million-unit annualized pace in May, down from 17.3 million in April and 17.8 million in March, as the tariff-driven front-loading of demand faded. Inventories are tightening, replacement costs are climbing, and with higher payments and fewer incentives, consumers are pulling back. Even areas that had been showing some resilience, like home furnishings and appliances, are now seeing volumes decline. That slowdown is likely to deepen this summer, especially in discretionary sectors.

Firms that once had pricing power are now shifting to a more defensive stance, prioritizing cost control over growth. Business confidence is retreating broadly—more sharply than at any time since the pandemic—with tariff uncertainty front and center. Unless there’s movement on trade policy or the budget negotiations, capital spending and hiring are likely to slow further in the months ahead.

A Strategic Shift in Ukraine Raises the Stakes

Kyiv’s long-range drone strikes on Russian airbases—dubbed Operation Spiderweb—may mark a pivotal moment in both the war and global security. The successful targeting of up to 41 high-value aircraft, including nuclear-capable bombers and early-warning systems, stands as one of the most significant asymmetric attacks in modern warfare. The damage—potentially over $7 billion—was notable, but the message was louder: Ukraine now has the capacity to strike deep into Russian territory using low-cost, domestically produced technology. The rapid follow-on strike on the Kerch Bridge only reinforced that message.

Ukraine’s surprising and effective strikes deep into Russia are a potential game changer.

These surprising and effective attacks are a potential game changer. For Russia, they reveal alarming vulnerabilities in its air defense and raise doubts about second-strike credibility, escalating the risk of retaliation. For global observers, they highlight the growing threat posed by scalable, decentralized warfare technologies—whether deployed by states or non-state actors. Markets have largely shrugged off the news, treating it as isolated, but that complacency may not last. Ukraine’s increasing tactical reach, combined with Russia’s declining strategic depth, suggests the conflict is entering a more volatile phase with greater tail risks.

The timing of the strikes was no accident. They came just before a new round of talks in Istanbul, signaling Kyiv’s stronger bargaining position. Though the talks produced little, Moscow’s decision to attend—just 48 hours after a major strategic blow—suggests it may be reassessing the cost of a prolonged war. Still, the path forward is fraught. If Putin sees his credibility eroding, the risk of sharp escalation—from large-scale retaliation to symbolic tactical strikes—will rise. Policymakers and investors should not underestimate the instability that could follow if the Kremlin feels boxed in.

Foreign exchange markets remain volatile amid diverging central bank policies and shifting capital flows. The dollar has softened notably in 2025, reversing much of its post-election rally, though it remains supported by interest rate differentials and safe-haven demand. Softer U.S. data and rising fiscal concerns have capped its upside and increased upside and downside risks. The euro has gained modestly as the ECB eases cautiously, while the yen remains under pressure from persistent yield gaps, despite growing intervention risks.

Looking Ahead: The Signal Is Shifting

Markets remain focused on inflation and monetary policy. With PCE inflation drifting lower and job growth softening, investors are pricing in a September rate cut. But the Fed has given no signal nor hinted what would trigger that signal. Policymakers remain in wait-and-see mode, watching how tariffs impact inflation expectations and supply chains.

The next round of data will be critical. The May CPI and PPI reports are due Wednesday and Thursday, followed by preliminary consumer sentiment on Friday. We expect the CPI to rise modestly but watch for signs of a further slowdown in shelter inflation and consumer durables. Also look for slight dip in inflation expectations and look what small business owners say about rising costs and their ability to pass them on.

The Week Ahead:

• Monday: Wholesale Inventories (April)
• Tuesday: NFIB Small Business Optimism (May)
• Wednesday: CPI (May), FOMC Rate Decision & Press Conference
• Thursday: Jobless Claims, PPI (May)
• Friday: University of Michigan Consumer Sentiment (June, prelim)