Mark Vitner

Driving Toward China

President Trump was not merely playing through at his Scottish golf resort last week—he was laying down the contours of a new trade regime. The U.S.-EU deal announced Sunday sidesteps a tariff spike just before the August 1 deadline, setting a 15% baseline tariff on most EU exports, including autos. That is a gentler swing than the 25% some had feared, but it still embeds lasting friction into the U.S.-Europe trade relationship.

Trump is not just negotiating trade—he is improving the lie ahead of the next big shot.

The bigger game remains China. As we noted in The CAVU Compass, Trump’s approach to trade diplomacy is less about bilateral wins and more about setting the global lie ahead of a final showdown. By locking in terms with allies—Japan, Vietnam, Indonesia, and now the EU—Trump is creating a global framework designed to isolate Beijing and force its hand on critical minerals, semiconductors, and intellectual property enforcement. China is currently engaged in talks ahead of the August 1 deadline and is widely expected to strike a deal.

The structure of Trump’s trade deals is evolving into a new form of strategic cooperation—not simply tariff relief, but access to U.S. markets in exchange for meaningful investment in American infrastructure and industrial capacity. The message is clear: allies may keep their trading lanes open if they help America re-industrialize. Countries are buying into the strategy as the most effective way to manage China’s rise. There is broad recognition that the United States must remain a credible counterweight to a more assertive China.

That help increasingly takes the form of large capital commitments—many of them supported by U.S. loan guarantees—to fund energy infrastructure, logistics, and defense supply chains. A prime example is the push to unlock vast reserves of natural gas in northern Alaska. Multiple bilateral discussions with Japan and South Korea have centered on financing export terminals, pipelines, and processing hubs to bring Alaskan LNG to Asia. Similar arrangements are in discussion for critical mineral processing, semiconductor packaging, and submarine cable networks. Energy is also a key pillar of the EU deal and is intended to reduce dependence on Russian natural gas.

This is industrial policy at global scale. The new model is part trade deal, part energy alliance, and part security compact. It redefines globalization as conditional access—with terms enforced not just by tariffs, but by capital flows and strategic alignment. Tariffs are likely to settle in at a 15% base rate on all imports to the United States, lower rates on U.S. exports, and higher rates on strategic sectors such as steel, aluminum, semiconductors, and electric vehicles. Investment pledges—largely structured as loans or loan guarantees—allow the administration to claim that most of the long-term financial benefit remains in the United States. Interest payments are not profits.

Both the Japan and EU deals were par fours—difficult, but straightforward plays from the fairway. The China deal, however, is shaping up to be a long par five—narrow, uphill, and fraught with hazards. The outcome will define not just the trade balance, but the structure of the global economy for decades to come.

Trade and the Treasury Market: Sand Traps Ahead

Markets greeted the EU trade deal with cautious optimism. Treasury yields initially moved higher overnight as risk sentiment improved, but the rally quickly faded. The long end of the curve remains vulnerable to supply concerns and lingering inflation risks, with the 10-year note briefly testing support near 4.5%. While the deal provided a modest lift to the dollar, the broader trend remains downward as the Fed edges closer to a dovish pivot and the terms of trade continue to deteriorate.

The U.S. remains the cleanest scorecard in the clubhouse—and likely to remain so.

Tariff revenues are climbing, but so are investor concerns about policy unpredictability and inflation passthrough. The flurry of recent trade agreements has reduced—but not eliminated—uncertainty. The dollar’s recent weakening reflects this shift, as global investors begin to question how long the U.S. can remain the cleanest scorecard in the clubhouse.

We remain confident that the dollar will hold its status as the world’s reserve currency for the foreseeable future. While increased foreign direct investment may require producers abroad to export more to the U.S. to finance those flows, the investment itself—and the economic growth it spurs—will ultimately boost returns on dollar-denominated assets. We expect near-term softness but anticipate dollar strength to return within 18 to 24 months.

Housing Loses Momentum

June’s existing home sales fell 2.7% to a 3.93 million annual pace, nearing post-GFC lows. The median existing home price climbed to a record $435,300, but that higher median price reflects a lack of inventory at the low end, not resurgent demand. Supply remains more than adequate at the upper end of the market. New home sales edged up just 0.6% to a 627,000 pace and are down 6.6% from a year ago. Builders are leaning on incentives and price cuts to sustain sales, but inventories of completed new homes continue to climb—now at their highest level since 2009. A substantial backlog of homes under construction also persists.

Single-family permits have declined for four straight months, underscoring increased caution among builders. Higher-end inventory is accumulating, while first-time buyers remain constrained by affordability challenges and high mortgage rates. We expect sidelined buyers to return as rates move closer to 6%, but a sustained recovery is unlikely until the labor market stabilizes. New hiring and job switching have both slowed sharply over the past year, reducing mobility for both renters and homeowners.

Business Investment: Chipping Away

Durable goods orders fell 9.3% in June, which was less than expected and only partially reversed the prior month’s 16.5% spike driven by a surge in commercial aircraft orders. Capital goods orders excluding aircraft and defense fell a larger-than-expected 0.7%, marking the third consecutive monthly decline and pulling the measure back into negative territory for the quarter. Business equipment shipments also slipped, suggesting that Q2 business investment will be soft following a strong Q1.

Policy uncertainty is clearly weighing on capital spending. Trade deals—especially provisions requiring reshoring to receive tariff relief—may eventually support investment, but in the short term they are raising costs and clouding visibility. Until the fairway clears, expect firms to play it safe and lay up.

Labor: No Longer Pin-Seeking

Initial jobless claims fell to 215,000—better than expected—but continued claims edged higher to 1.96 million. The divergence suggests a labor market in transition: layoffs remain low, but hiring is slowing. Quits are down, long-term unemployment is ticking up, and recent federal layoffs—enabled by a Supreme Court ruling that curbed agency protections—are beginning to register in the data. AI adoption may also be dampening hiring in the near term, even as it boosts productivity over time. In June, private employers added just 74,000 jobs, and a separate report from ADP showed private sector headcount declining by 33,000.

The recent softness in labor market data is unlikely to trigger a panic rate cut, but it does strengthen the dovish case. Wage growth has moderated, and if the July jobs report shows sub-trend gains or an uptick in the unemployment rate, momentum could shift more decisively toward easing. The unemployment rate, however, may remain artificially low in the near term due to tighter immigration enforcement and an accelerating wave of Baby Boomer retirements.

We are looking for a soft July payroll print this Friday, with nonfarm payrolls rising by just 95,000 jobs. The unemployment rate should edge higher to 4.2%.

Geopolitics: Pressure Points, Limited Market Reaction

Two geopolitical flashpoints dominated headlines last week but left financial markets largely unmoved.

In the Middle East, renewed rocket fire from Hamas prompted fresh Israeli airstrikes in Gaza, escalating a conflict already marked by deep humanitarian strain. Civilian casualties are rising, and critical infrastructure in Gaza remains decimated. U.S. and regional mediators—including Egypt and Qatar—are pushing to restart talks, though the prospects for a durable cease-fire remain slim. Washington has urged Israeli restraint, citing risks to regional energy flows and the fragile stability underpinning the Abraham Accords.

Hamas continues to pursue a strategy aimed at maximizing civilian casualties and leveraging global media to generate sympathy abroad. The group’s stated objective—the eradication of Israel—stands in stark contrast to the portrayal in many widely circulated images, including two this weekend that were factually misleading. One featured a child with cerebral palsy, falsely presented as a typical Gaza victim; the other showed a child receiving long-term medical care in Italy for unrelated reasons.

Israel has consistently found itself on the defensive in the global PR war, with critical coverage emerging before it even responds to attacks. That dynamic has prompted Israel to take more assertive steps to deliver aid, including parachuting in humanitarian supplies—provided by other governments—via IDF aircraft. There is no viable resolution to the conflict that allows Hamas to remain in power, and the longer Hamas holds control, the more the people of Gaza are likely to suffer. That view is not unique to Israel; it is shared by several Arab governments in the region.

In Southeast Asia, Thailand and Cambodia agreed to an unconditional cease-fire after five days of deadly clashes along their contested border. The conflict, rooted in a century-old dispute over ancient temple sites, displaced more than 300,000 civilians and claimed at least 35 lives—mostly noncombatants. A breakthrough came after President Trump made a cease-fire a precondition for further trade talks, threatening a 36% reciprocal tariff on Thai and Cambodian exports. The deal was brokered in Kuala Lumpur by Malaysian Prime Minister Anwar Ibrahim, with quiet support from both U.S. and Chinese officials.

Despite the use of drones, naval assets, and heavy weaponry, markets barely reacted. Risk assets held steady, oil prices remained stable, and Treasury yields stayed within recent ranges.

The muted response reflects a familiar pattern: unless geopolitical shocks directly threaten global supply chains or major energy corridors, markets are inclined to look through them. Still, the growing use of trade tools to influence regional conflict outcomes is a trend worth watching—particularly as tariff diplomacy increasingly doubles as security policy.

The Turn: Tight Lies and Tighter Margins

This week will tell us a lot—about where the economy stands, where it’s headed, and how much room the Fed has to maneuver.

Wednesday’s FOMC meeting will anchor the week, with Powell expected to strike a more cautious tone. Thursday brings the June PCE inflation report and the Employment Cost Index. Friday delivers the July payrolls report, ISM manufacturing data, and consumer sentiment.

Markets are also watching trade. August 1 marks the formal implementation date for the new tariff regime. Last-minute exemptions are still possible, but the direction is set: more trade friction, more policy uncertainty, and greater reliance on industrial strategy over free trade.

On the earnings front, over 150 S&P 500 firms will report—including Apple, Amazon, Microsoft, and Meta. Corporate commentary on hiring, pricing, and investment will provide critical insight into how companies are adjusting to higher costs and slower demand.

The Fed may be nearing a rate cut, but this is no easy putt. The economic recovery remains intact—but vulnerable. Tariff policy is distorting inflation signals, business investment is fading, and the labor market is losing altitude. With each deal struck, the stakes grow higher for the U.S.-China endgame—and the global fairway narrows.

This Week’s Scorecard: Key Data on the Tee

Tuesday, July 29 – Opening Shots

• Advance Goods Trade Balance (June)
  Expect a widening deficit as exports slow and pre-tariff imports remain elevated.
• Wholesale Inventories (June, preliminary)
  Inventories likely dipped slightly, playing it safe from the rough. A larger drop would cause forecasters to scale back Q2 GDP estimates.
• FHFA House Price Index (May)
  Continued declines expected as sellers adjust to tighter conditions.
• S&P Case-Shiller Home Price Index (May)
  Price softness is deepening, particularly in Florida and Texas, with more markets joining the slide.
• JOLTS (June)
  Openings likely declined again; many remain posted but unfilled. The quits rate is the one to watch.
• Consumer Confidence (July)
  A modest rebound is expected, helped by easing tariff concerns and steadier market conditions—though labor market nerves could hold sentiment back.

Wednesday, July 30 – The Mid-Round Turn

• ADP Employment Change (July)
  Following last month’s miss-hit, expect a partial recovery—about +55,000—plus possible revisions.
• Q2 Advance GDP
  Forecasted at +2.6%, powered by net exports and moderate consumption. Atlanta Fed GDPNow is tracking at 2.4%.
• Pending Home Sales (June)
  A slight gain is likely, supported by lower mortgage rates and a small lift in purchase applications.
• 2:00 PM – FOMC Statement
• 2:30 PM – Chair Powell Press Conference

Thursday, July 31 – Staying in the Fairway

• Employment Cost Index (Q2)
  Expected to rise 0.8%, with annual wage growth easing to 3.5%. A slight fade from earlier strength.
• Personal Income & Spending (June)
  Income +0.3%, spending +0.2%. Core and headline PCE expected at +0.3%, though a softer read is possible on core.

Friday, August 1 – A Crucial Approach

• Nonfarm Payrolls (July)
  Job growth is expected to slow to +90,000, with the unemployment rate ticking up to 4.2%. Hiring restraint and seasonality are in play.
• ISM Manufacturing Index (July)
  Still under par at just below 50. Defense and tech are driving modest strength, while construction and consumer sectors struggle.
• Construction Spending (June)
  Residential and commercial weakness continues, though infrastructure may provide a lift from the sand trap.
• University of Michigan Consumer Sentiment (July, final)
  Sentiment should edge higher with steadier inflation expectations and market gains—but survey polarization remains a hazard.

Final Putt: A Narrow Fairway Ahead

As the Fed eyes the back nine, the course ahead grows more complex. This is not merely the halfway point—it is the start of a tougher stretch where precision matters, hazards multiply, and the margin for error narrows. How we navigate this stretch won’t just determine the score this round—it will shape the course we play going forward.

Disinflation Holds, but Tariffs Cast a Longer Shadow

June’s inflation data reaffirmed that disinflation remains intact, though not without friction. Core CPI rose 0.23% month-over-month, slightly below expectations, while the year-over-year pace edged up to 2.9%. Headline CPI increased 0.29%, driven by energy and food. Softer categories like lodging (-2.9%), used cars (-0.7%), and new vehicles (-0.3%) helped contain the core, while goods likely impacted by early-stage tariffs—furnishings, apparel, toys, and sporting goods—saw price gains between 1.0% and 1.8%.

Inflation Slows Below the Surface as Trade Pressures Begin to Break Through.

More notably, core services excluding housing—a key focus area for the Fed—rose just 0.27% in June and is up less than 3% year-to-year, which is the slowest pace since it started climbing in the fall of 2021. Medical care, recreation, and transportation services all moderated, signaling that some of the stickiest components of inflation may be easing.

PPI and import price data supported this mixed view. Final demand PPI rose more than expected, with core goods prices up 0.4%. Import prices excluding petroleum were flat, even though consumer goods rose 0.4%, likely tied to tariffs. The BLS also flagged outsized increases in capital equipment and industrial supplies—both categories heavily exposed to tariffs.

Tariff-related cost pressures are surfacing across multiple channels. The latest Beige Book cited “moderate to pronounced” input cost increases in every district. While many firms are still absorbing these costs, most expect to raise prices in the second half of the year. Tighter immigration enforcement is also contributing to labor constraints in skilled services, raising the potential for wage pressure.

Tariffs pass-through is being restrained by slower income growth.

Even so, the broader inflation trend remains favorable. Shelter costs are easing gradually. Core goods, which is where tariffs will most clearly be evident, are firming less than feared, and energy prices, while volatile, remain below year-ago levels. The Fed can take comfort in the direction of travel—but the terrain is uncertain. If pass-through accelerates or wage gains broaden, the glidepath to 2% may grow bumpier.

Real average hourly earnings slipped 0.1% in June, marking the second drop in the past three months. Real weekly earnings fell 0.4%, as inflation outpaced nominal pay gains and the average workweek shortened. Year-over-year, real earnings are still up 1.0%, but momentum is weakening. This deceleration is already weighing on discretionary spending and will likely continue to act as a soft brake on household demand in the second half.

Retail sales in June rose a stronger-than-expected 0.6%, with control group sales up 0.5%. However, downward revisions to April and May dragged the three-month annualized trend in control group sales, which are used to estimate the goods portion of personal consumption expenditures, to a 3.2% pace. The squeeze is especially visible among middle-income households grappling with elevated housing, insurance, and utility costs.

Nominal gains were broad-based, but real volumes told a more nuanced story. Rising goods prices, likely held real goods spending to just a 0.5% pace. Sales declined at electronics and furniture stores—two of the most tariff-sensitive categories—suggesting price hikes are masking even greater real volume weakness. Bars and restaurants rebounded modestly, but discretionary spending on travel and hospitality remains under pressure.

The July University of Michigan consumer sentiment index ticked up to 61.8, marking the second consecutive monthly gain. Year-ahead inflation expectations fell to 4.4%, with long-term expectations easing to 3.6%—the lowest since February. Yet sentiment among low-income households deteriorated, reflecting the early impact of tariffs and the absence of wealth effects from equity gains. The bifurcation in consumer resilience is likely to deepen as fiscal policy changes and higher import costs take hold.

The global trade environment continues to grow more fragmented. Tighter enforcement of transshipment rules and conditional tariff arrangements with Vietnam and Indonesia are raising compliance costs and introducing new frictions into global supply chains. U.S. exporters face weak global demand, limited pricing power, and elevated shipping costs.

Despite these headwinds, several industrial sectors are showing resilience. U.S. industrial production rose 0.3% in June, underpinned by strength in utilities and primary metals. Manufacturing output edged 0.1% higher, surprising to the upside amid expectations for a decline. While motor vehicle production pulled back following a surge earlier in the year, output in high-tech equipment, aerospace, and primary metals continued to climb. The Philadelphia Fed’s July Manufacturing Survey added to the positive tone, with the general activity index rebounding to +15.9—its highest level since February—and indicators for new orders and shipments also rising sharply.

Steelmakers are boosting output, buoyed by strengthening demand and a supportive tariff environment. Aerospace is benefiting from improved manufacturing systems, as well as ramped-up defense spending and stronger international demand. High-tech manufacturing continues to lead in productivity and investment, with strength concentrated in electronics, automation, and digital infrastructure.

Red Lines, Flashpoints, and Political Crosswinds

Geopolitical tensions are intensifying across multiple fronts. In Ukraine, Russian strikes have escalated in Kyiv and Kharkiv, with mounting civilian casualties. President Trump reaffirmed U.S. support but warned that secondary tariffs may be imposed on countries maintaining commercial ties with Russia—putting India, Brazil, and Turkey on notice. The threat introduces the potential for major strains in global trade and investment flows.

In the Middle East, Israel has opened a second northern front following a wave of cross-border attacks by Iranian-backed militias on Druze civilians. Airstrikes on Syrian army positions killed over 300, even as Houthi attacks persist in the south. The fighting put normalization talks with Saudi Arabia on hold. We still expect to see Saudi Arabia, Lebanon, and perhaps Syria, reach an agreement with Israel, as they seize on the opportunity presented by a weakened Iran.

Markets appear complacent. Secondary sanctions could redraw global energy and commodity trade routes, adding volatility and inflation risk. Increased support for Ukraine comes at a time of intense budget pressures in the U.S., resulting in some crafty arrangements with NATO allies. Surprises from the Middle East always hold potential to disrupt the markets in a number of ways.

Meanwhile, Japan’s snap election delivered a fractured outcome. Prime Minister Kishida’s ruling coalition held power but lost its supermajority, weakening the mandate for deeper reform. But the result did not derail progress on trade negotiations. The U.S. and Japan announced a sweeping trade agreement this week, with President Trump confirming a reciprocal 15% tariff rate and Japan pledging $550 billion in U.S. investment—including joint ventures in LNG and critical industries. Automotive tariffs, a key sticking point, were reduced from 25% to 15%, offering major relief to Japan’s export-driven economy. Markets welcomed the deal. The Nikkei closed 3.5% higher.

Looking Ahead: The Glidepath Narrows

The Conference Board’s Leading Economic Index fell 0.2% in June—marking its 17th decline in the past 18 months—and is down 2.8% over the past six months. While the index continues to signal recession risk, weakness remains concentrated in softer survey-based components. Hard data—payrolls, industrial production, and real retail sales—point to a decelerating but still expanding economy.

This week’s housing focused calendar could shape expectations ahead of the Fed’s July 31 decision:

• Wednesday, July 23 (today):
  • Existing Home Sales (June) declined to 3.93 million SAAR, slightly below expectations. Rising inventories of completed new homes are providing competition for existing homes, as builder incentives attract buyers.
• Thursday, July 24:
  • S&P Global Flash PMIs (July) June’s PMI data showed global growth supported by a pickup in manufacturing—its fastest pace since February—even as services activity cooled. Input cost pressures stabilized.
  • New Home Sales (June) – expected to rebound modestly, supported by builder incentives and rising inventories of completed homes.
• Friday, July 25:
  • Durable Goods Orders (June) – headline orders are expected to rise 0.7%. Core capital goods orders, a proxy for business fixed investment, will be closely watched.
• Monday, July 28:
  • University of Michigan Consumer Sentiment (final, July) – expected to confirm the preliminary reading of 61.8 and year-ahead inflation expectations, which eased to 4.4%. Long-term expectations fell to 3.6%, the lowest since February.
• Thursday, August 1:
  • Q2 Advance GDP Estimate – expected to show 2.6% annualized growth, supported by a smaller trade deficit, modest gains in consumption, and more support from business inventories than previously expected.

Markets continue to price in 75bps of cuts by year-end. The Fed is expected to hold steady next week, but the data is trending in favor of a September cut. Financial conditions are easing, but the margin for error is narrowing as labor market softness becomes more visible and trade risks reemerge.

The Glidepath Narrows

The Fed is approaching closer to cutting rates. The data supports a cut. Treasury yields are under pressure, and market liquidity is thinning. Margins are narrowing—not just for corporations, but for policymakers. The glidepath remains intact, but the descent is rougher than expected. Expect volatility to pick up in August, with rising odds of coordinated action between the Fed and Treasury

Patience May be a Virtue but Often Comes at a Cost

The Federal Reserve’s cautious stance, reinforced by this week’s FOMC minutes, is increasingly at odds with an economy showing obvious signs of fatigue. While most Fed officials remain inclined to wait for more conclusive evidence that inflation is on a sustained path to 2%, labor market data looks softer beneath the surface, and renewed trade tensions suggest the window for a soft landing may be narrowing. President Trump’s critique of Jerome Powell—labeling him “too late”—may be political theater, but it underscores a growing concern: the longer the Fed waits, the greater the risk that it misses its opportunity to act.

The pressure on the Fed may make it tougher for Powell to cut rates earlier, even if he needs to.

Ironically, the pressure from President Trump may complicate the Fed’s ability to react. A rate cut in the near term could be perceived as a concession to political pressure—undermining the Fed’s independence, weakening the dollar, and unsettling bond markets. This political overhang makes it harder for policymakers to act decisively, even as economic momentum softens beneath the surface. We believe the July FOMC decision will be a closer call than the markets currently expect but still see the kickoff for the next round of rate cuts coming in September.

The June FOMC minutes confirmed that while a vocal minority supports earlier rate cuts, most committee members remain focused on the slow and uneven pass-through of tariffs into inflation. The stronger-than-expected June payrolls report provided cover to hold rates steady, but labor market fundamentals are clearly deteriorating. Hiring has slowed across most sectors, and job gains are increasingly concentrated in just a few industries. Alternative data—including the Bureau of Labor Statistics’ QCEW and ADP’s private payroll figures—suggest job growth has been overstated, with actual payroll gains running at least one-third below headline estimates over the past year.

Hiring has stalled, layoffs remain low, and the labor market is stuck in neutral.

High-frequency and survey data reinforce this softer assessment. Continuing unemployment claims have climbed to a post-pandemic high of 1.965 million, while initial claims have edged down to 227,000. This divergence points to a stagnant labor market marked by less hiring and less firing—a regime where laid-off workers, new entrants, and re-entrants struggle to find jobs as employers remain cautious amid soft demand and tariff uncertainty. The Conference Board’s Consumer Confidence Survey and the NFIB Small Business Optimism Index show that jobs are less plentiful and that hiring has slowed.

A stagnant labor market is not a healthy one. In a dynamic economy, workers leave jobs for better opportunities, and employers actively recruit to fill openings—supporting productivity, wage gains, and stronger growth. Today’s picture is more muted. Job growth has narrowed to pockets like healthcare, while cyclical industries are losing traction. Small businesses are at the center of the slowdown. The NFIB’s June survey showed optimism dipping to 98.6, driven by rising inventories, falling sales expectations, and weak hiring plans. Wage pressures are easing not because inflation expectations have normalized, but because labor demand is weakening.

The evolving tariff landscape adds another layer of complexity. This week, President Trump extended the July 9 tariff deadline to August 1 and proposed raising duties on 16 countries unless new deals are reached. While the new rates largely mirror those outlined in April and are unlikely to be fully implemented, they introduce a renewed layer of uncertainty into business planning—delaying capital expenditures, inventory restocking, and hiring decisions.

One lingering question is why this latest wave of tariffs has not shown up in consumer prices. The answer lies in delayed transmission, frontloading of imports, and absorption across the supply chain. Many of the goods hit by April’s tariffs did not arrive until May due to “on-the-water” exemptions. In addition, tariff payments can be deferred for up to six weeks, and many firms waited to raise prices until it became clear whether the tariffs would stick. Businesses also had some margin flexibility and ability to pressure suppliers, while consumers have shown strong resistance to price increases—especially with household budgets squeezed by housing, food, and transportation costs.

We estimate that roughly 35 percent of the current tariff burden has been absorbed by foreign producers, 40 percent by U.S. businesses, and just 25 percent by consumers. Alternative data and business surveys suggest the passthrough to consumer prices has been more limited than during the 2018–2019 tariff experience—likely due to more elastic supply chains and weaker household finances. If new tariffs take effect in August, consumer exposure may increase, but the broader inflationary impact remains constrained.

Our out-of-consensus view remains that fears of tariff-driven inflation are overstated. Roughly two-thirds of U.S. consumer spending is for services, which are unaffected by tariffs. Of the one-third spent on goods, only a portion is for imported goods. With consumer budgets already strained—particularly for households earning under $100,000—businesses are finding it difficult to pass on cost increases. In fact, the overall effect may prove disinflationary, as tariffs function more like a consumption tax and reduce spending for other goods and services. Soaring tariff revenues at the U.S. Treasury lend weight to that argument.

Despite rising risks, markets remain unusually calm—for now. Implied volatility across FX and fixed income has declined, anchored by steady inflation expectations and a lack of acute macro shocks. But realized volatility in equities and bonds continues to outpace implied levels, suggesting options markets may be underpricing near-term risks. With volatility risk premia compressed, investor complacency could set the stage for a sharp repricing—especially if trade tensions flare or policy credibility erodes. The month of August often brings big surprises.

Real yields near 2% signal a fragile equilibrium. The 10-year TIPS yield hovers near post-GFC highs, reflecting high nominal rates and subdued long-term inflation expectations. While that level aligns with estimates of trend growth, it also underscores growing fragility. Financialization, elevated leverage, and weak productivity have increased the economy’s sensitivity to shocks. As central banks transition from pandemic-era support to neutral or tighter policy, these real rates may begin to bite—tightening credit, curbing investment, and raising the odds of a hard landing.

Against that backdrop, a defensive stance remains prudent. Valuations are stretched, macro momentum is fading, and the outlook for a broad equity rally in the second half is weak—despite enthusiasm around AI and the emerging defense-tech buildout. July’s fiscal stimulus may offer support in 2026, but for now, a rebound in small business sentiment, capital spending, and hiring appears remote—particularly with a new round of tariffs in play.

The latest tariff announcements are puzzling in tone but fairly clear in intent: contain China, support strategic industries, and monetize access to the U.S. consumer market. Rhetoric aside, the message is simple—foreign firms will pay to play. The Trump administration is also taking a harder line on transshipping and fentanyl, where China remains the primary bad actor, but close allies—including Canada and Mexico—play supporting roles. While most fentanyl intercepted at the border enters via Mexico, Canada is a known source of key precursor chemicals. China has agreed to ban production of several precursors effective July 20, and the U.S. and Canada are scheduled to meet on July 21, with a potential agreement expected to follow.

The 35% tariff on Canadian goods announced July 10 would raise duties from 25% on targeted items such as non-USMCA-compliant lumber and dairy, while exempting compliant products—which account for 40% of bilateral trade—as well as steel, aluminum, autos, copper, and energy goods including oil and potash. These issues are also expected to be addressed during upcoming talks.

Asymmetric Pressure: Fentanyl and Rare Earths

The flurry of tariffs and trade deals reflects President Trump’s effort to boost federal revenues in exchange for access to the U.S. market, correct longstanding trade imbalances, support the reshoring of critical manufacturing, and counter China’s systematic exploitation of asymmetric vulnerabilities in the U.S. economy. Two recent developments illustrate the stakes: the rise of fentanyl as a tool of destabilization and the weaponization of rare earth supply chains.

China’s role in the fentanyl crisis aligns with its doctrine of “unrestricted warfare.” By enabling transnational criminal networks and shielding fentanyl producers behind state-controlled pharmaceutical infrastructure, the CCP has built an “unassailable base” for synthetic drug manufacturing. The result: over 100,000 annual U.S. overdose deaths, rising health costs, and hollowed-out communities—all while remaining below the threshold of conventional conflict.

China’s rare earth chokehold threatens U.S. military strength and industrial competitiveness.

At the same time, China’s April 2025 decision to restrict exports of seven rare earth elements sent shockwaves through the U.S. defense and manufacturing sectors. China mines over 65% of the world’s rare earths and controls more than 85% of global refining capacity. By dominating nearly 90% of high-performance magnet production, China maintains a chokehold on critical supply chains for missiles, fighter jets, satellites, and electric vehicles. These latest restrictions follow earlier bans on gallium and germanium—materials essential to radar, infrared systems, and semiconductors. This is not merely economic leverage; it is a direct challenge to U.S. military readiness. A true Sputnik moment.

A $3 billion public-private partnership between the Pentagon and MP Materials marks progress toward magnet independence, but full production likely will not begin until 2027 or later. Without stronger incentives and binding agreements with allies, the U.S. remains dangerously exposed. Fentanyl and minerals are not separate challenges—they are part of a coordinated asymmetric strategy aimed at weakening U.S. power and resilience.[1]

Next week, senior U.S. officials will participate in a series of high-level talks across sub-Saharan Africa, including bilateral meetings in Kenya and mineral security discussions with Angola and South Africa. These meetings come at a pivotal time, as the U.S. seeks to counter China’s growing economic and strategic footprint on the continent and reinforce ties with nations critical to global supply chain resilience.

[1] Macdonald Amoah, Morgan Bazilian, and Jahara Matisek, Minerals, Magnets, and Military Capability: China’s Rare Earth Weaponization Should Be a Wake-Up Call, Modern Warfare Institute. July 10, 2025.

Inflation, Inventories, and the August 1 Tariff Clock

The week ahead will test whether the Fed can afford to continue sitting on the sidelines. The data slate includes June CPI and PPI, retail sales, industrial production, housing starts, and the Fed’s Beige Book—each offering critical insight into whether the balance of risks is weighted toward higher inflation or slumping economic growth.

We expect CPI to come in slightly below expectations, with the headline rising 0.3% but the core CPI rising just 0.2%. The recent slide in energy prices should slightly reverse in June. Food prices may also surprise to the upside, led by beef. Core goods prices continue to post modest increases, although we expect some snapback in airline fares and used car prices. Residential rent should moderate further. Producer prices are expected to match or slightly exceed the CPI—reinforcing our view that margins are absorbing much of the hit from higher tariffs.

Look for another flat industrial production reading, with most cyclical sectors down slightly and gains in defense, aerospace, and technology sectors. Retail sales are expected to rise a modest 0.3%, with weak auto sales offset by gains in building materials and restaurant spending. The control group should rise 0.4%. Inventory accumulation remains soft.

And then there’s trade. Unless negotiations succeed by August 1, U.S. tariff rates will rise across a wide range of imports. We expect to see a few more deals signed, but countries are increasingly concerned that early concessions will only invite greater demands later. We see the tariff endgame as a 10% universal rate, paired with elevated duties on goods originating in China—regardless of final assembly location. Higher rates will likely apply even to trade with Canada and Mexico.

The Fed’s Beige Book will be watched for anecdotal insights on hiring, pricing (tariff pass-through?), and investment sentiment—qualitative signals that may shape the tone of the July and September FOMC meetings, especially given ongoing data volatility, low confidence, and still high inflation expectations.

Looking Ahead: Week of July 14–18

• CPI (Tuesday, July 15): Headline (+0.3%, 2.7% yr/yr). Core (+0.2%, 2.9% yr/yr).
• PPI (Wednesday, July 16): PPI Final Demand (+0.2%). Core PPI (+0.2%).
• Industrial Production (Wednesday, July 16): Overall (+0.2%), Manufacturing (0.1%). Gains in aerospace offset minor declines elsewhere.
• Retail Sales (Thursday, July 17): Overall retail sales (+0.1%). Ex-Autos (+0.3%). Core (+0.4%).
• Import Prices, Initial Claims and Business Inventories (Thursday, July 18): The torrent of data will lead to some final tweaks in Q2 GDP forecasts. We are currently at 2.9%.
• Housing Starts (Friday, July 18): Look for a slight rebound following last month’s 9.8% plunge. Overall Starts (+2.5%). Building Permits (-2.0%).

Final Thought: Timing is Everything

The Fed’s patience is understandable, but the risks of delay are growing. A stagnant labor market, weak small business sentiment, and tariff-driven uncertainty are tightening the noose around the recovery. The central bank still has time—but not much. In a cycle increasingly defined by policy lag and global volatility, timing is not just everything—it is the only thing.