#Fed #USEconomics

Yesterday, we tried to understand how the stock market manages to grow and set new records while macroeconomic data signals slowing and even contracting economy. Today, we will analyze fresh reports and recent statements to understand how the Federal Reserve (Fed) and the changing economic picture continue to shape this seemingly illogical scenario.

1. Euphoria, supported by new hope, continues,

Thesis: The rally in the U.S. stock market retains its strength, fueled by persistent optimism regarding the easing of trade policy and growing confidence in upcoming Fed rate cuts that successfully offset negative economic signals.
Analysis: The S&P 500 and Nasdaq 100 indices reached new record highs, rising by 0.3%, while the Dow Jones opened up by 278 points or 0.64%. This is not just broad market growth: individual stocks are also showing impressive dynamics. For example, Nike surged by 14.60% after strong financial results, Amazon added 1.65%, and Intuit, Boston Scientific, and Boeing (2.21%) also reached new highs or saw significant increases. This bullish sentiment is largely explained not only by expectations of a "dovish" Fed pivot providing cheap liquidity, but also by concrete steps to ease trade policy. Statements from Commerce Secretary Raimondo about reaching a trade agreement with China, consolidating tariff reductions, and preventing a rare earth metal shortage, as well as hints of progress in deals with other countries (including India), reduce uncertainty and support corporate earnings. Additionally, the repeal of Section 899 tax contributes to an influx of foreign investments, which is also positively perceived by the market.

2. U.S. economic slowdown: The Fed under the spotlight of "bad news" and ambiguous signals

Thesis: Compelling and strengthening evidence of slowing economic activity in the U.S. continues to pressure the Fed, pushing it towards a more aggressive rate-cutting cycle, which reinforces the principle of "the worse, the better" for the stock market, although new data on consumer sentiment adds nuance.
Analysis: Recent economic data continues to paint a picture of a cooling economy, strengthening arguments for Fed action. Personal spending and income unexpectedly fell in May, with personal income dropping 0.4%, marking the first decline since September 2021. Gross domestic product (GDP) in the first quarter, as we discussed, contracted by 0.5%, and unemployment claims reached their highest level since 2021. This data, combined with the notably "dovish" tone of Fed Chair Powell in Congress, reinforces market expectations for imminent and multiple rate cuts. Markets are now pricing in 64 basis points of rate cuts for 2025, significantly higher than previously expected. Furthermore, political speculation around a possible appointment of a new Fed Chair by President Trump could further amplify the "dovish" direction of monetary policy, adding another layer of expectation.

Notably, the University of Michigan's consumer sentiment index was revised slightly upward to 60.7 in June 2025 (up from a preliminary 60.5), marking the first increase in six months and reflecting improved expectations regarding personal finances and business conditions. However, despite this increase, sentiment remains about 18% lower than in December 2024, indicating a continued expectation of economic slowdown.

3. The inflation paradox: Resilience of core PCE against falling inflation expectations

Thesis: Despite the overall slowdown in consumer spending and income, as well as GDP contraction, the core PCE price index — the Fed's preferred inflation indicator — showed a slight acceleration, creating a complex and delicate dilemma for monetary policy, which is exacerbated when compared to sharply falling consumer inflation expectations.
Analysis: The overall PCE price index rose by 0.1% month-on-month in May, in line with forecasts. However, the core PCE index (excluding volatile food and energy prices) rose by 0.2% month-on-month, exceeding both forecasts and previous values. Year-on-year, core PCE inflation accelerated to 2.7% from 2.6%. This contrast between the slowdown in consumer activity and the resilience of core inflation (especially in the services sector, where prices rose by 0.2%) puts the Fed in a position where it must carefully balance supporting economic growth and controlling prices.

However, new data from the University of Michigan shows that annual consumer inflation expectations sharply declined to 5% in June 2025 (down from 6.6% in May, which was the highest since November 1981). Long-term inflation expectations (five years) were also revised downward to 4.0%. This "elephant in the room" becomes even more puzzling: while current PCE data shows a slight acceleration in core inflation, consumer inflation expectations are significantly decreasing. For the Fed, which closely monitors inflation expectations, this could become an important argument for rate cuts, as it indicates a lack of entrenched inflation pressures.

4. The dollar and bonds: A mirror of aggressive expectations

Thesis: The weakening of the U.S. dollar and the decline in Treasury yields continue to be a direct reflection of growing and increasingly aggressive market expectations regarding Fed rate cuts, making the dollar less attractive and bonds more expensive.
Analysis: The dollar index (DXY) fell to 97.1 points, the lowest level since February 2022, extending a weekly decline of nearly 2%. The dollar weakened to a three-and-a-half-year low against the euro and the British pound, as well as to multi-month lows against other major currencies. At the same time, the yield on 10-year U.S. Treasury bonds remained around 4.26%, the lowest since early May. These movements clearly signal that investors are actively re-evaluating assets based on the prospect of a more accommodative monetary policy. The decline in DXY is also linked to the easing of trade tensions reducing demand for the dollar as a safe-haven asset.

Factor analysis

  • Drivers of Fed monetary policy:

    • Deteriorating macroeconomic data: Declining personal spending and income, falling GDP, rising unemployment claims — all of this creates a strong argument for the Fed in favor of stimulating the economy.

    • "Dovish" rhetoric from leadership: Open statements by Chair Powell about readiness to cut rates actively shape market expectations.

    • Political pressure: Speculation about the possible appointment of a new Fed Chair oriented towards easing policy strengthens these expectations.

    • Ambiguous inflation signals: Resilience of core PCE, but with a sharp decline in consumer inflation expectations (University of Michigan), giving the Fed more flexibility to ease policy.

  • Factors influencing the stock market:

    • Prospects for interest rates: Lower rates reduce borrowing costs and increase asset values.

    • Improvement in trade relations: Easing tariffs and concluding trade agreements positively impact corporate profits.

    • Corporate earnings: Selective strong results from companies (Nike, Amazon, Boeing) support the overall market dynamics.

    • Waiting for liquidity influx: Investors are preparing for "cheap money" that may flood the market.

  • Factors influencing the currency and debt markets:

    • Interest rate differentials: Expected rate cuts in the U.S. reduce the yield on dollar assets, making them less attractive.

    • Risk appetite: Improved market sentiment leads to capital outflows from safe assets like the dollar.

    • Inflation expectations: While core inflation remains steady, falling consumer inflation expectations dominate, supporting rate cut expectations and affecting bond yields.

Conclusions

  • The divergence is increasing, but with nuances: There is an increasingly pronounced split between the weakening real economy and the soaring stock market, driven solely by expectations of future liquidity. Meanwhile, the modest rise in consumer sentiment adds an element of ambiguity to the overall slowdown picture.

  • The Fed at a crossroads, but the path to rate cuts becomes clearer: The Fed faces a challenging task: to support the slowing economy with rate cuts without allowing inflation to spiral. However, the sharp decline in consumer inflation expectations, despite the resilience of core PCE, may give the Fed more confidence to begin the easing cycle. Their decisions will be critical.

  • Dollar under pressure: The weakening of the U.S. dollar is a direct and ongoing consequence of market expectations for rate cuts. This trend may persist as long as the Fed signals a "dovish" policy.

  • Bonds as a barometer: Treasury yields remain subdued, accurately reflecting investors' aggressive bets on rate cuts.

  • Inflation surprise changes the nature: Typically, an inflation surprise means that actual inflation deviates significantly from forecasts. Currently, we see a unique situation: while core PCE inflation has slightly accelerated (a surprise upward), consumer inflation expectations have sharply decreased (a surprise downward). This contradiction gives the Fed more maneuvering room, as it can interpret the decline in expectations as a signal that inflation is not taking root, which in turn strengthens arguments for rate cuts and reduces risks for current market optimism.