Inside Markets — From Resilience to Strength

Our tactically bullish fundamental outlook requires economic resilience, earnings growth and improved trade rhetoric. Stronger Q2 earnings growth was a relatively easy call given deeper-than-usual downside estimate revisions in April and May, while we assigned lower probabilities to the other two pieces of the narrative. Trade rhetoric seems to have taken a more hawkish turn with Trump unwilling to grant extensions beyond August 1, but markets are pricing an eventually lower effective tariff rate as negotiations are expected to be ongoing. The U.S. economy has remained resilient, while today’s data is flashing signs of outright strength.

Going forward, policy clarity from the recently signed tax cut/budget bill should provide a tailwind on its own, while its stimulative impulse seems underappreciated. On their own, tariff-related price adjustments should not be characterized as ‘inflation’. Measures of underlying inflation should face tariff-related upward pressure in coming months that will likely peak by early fall. From a macro-economic perspective, inflation is caused when money supply growth exceeds productive capacity – and the recently signed tax bill is full of incentives to increase productive capacity. Note that 1-year inflation breakeven yields have fallen from 411 bp in March to 282 bp today and the 12-month forward OIS curve remains priced for 90 bp of rate cuts.