Tariffs, inflation and the long shadow of policy error

Economic

Political

Summary:

Ever since the federal funds rate reached 5.50% in response to generationally high inflation, we’ve expressed concern about the risk of policy error should the U.S. central bank blink by prematurely easing policy before the inflation threat is fully vanquished.

Head of Global Asset Allocation Ashwin Alankar explains how his concerns about premature policy accommodation unleashing a second wave of inflation have grown due to the risks posed by tariffs.

We are not implying that the renowned Spanish philosopher was specifically speaking about monetary policy in 2025 when he penned the statement above, but given the unfolding economic environment, it could be seen as a heads up to the Federal Reserve (Fed).Ever since the federal funds rate reached 5.50% in response to generationally high inflation, we’ve expressed concern about the risk of policy error should the U.S. central bank blink by prematurely easing policy before the inflation threat is fully vanquished. As seen in the chart below, this is what occurred during the 1970s when the Arthur Burns-led Fed – either through miscalculation or losing its nerve – lowered rates before the job was done, thus unleashing a second, even more fierce, inflationary wave.

Tariffs, inflation and the long shadow of policy error_1

Source: Bloomberg, Janus Henderson Investors, as of 18 July 2025. Note: The Atlanta Fed’s designation of “sticky” inflation are those categories whose price levels are slow to change based on their frequency of price adjustments.

As far back as mid-2022, we have identified policy error as a tail risk that could potentially upend the trajectory of a surprisingly extended economic cycle. Importantly, this was before the threat of tariff-related supply distortions emerged. It was also before rumors began circulating about President Trump potentially replacing Fed Chair Jerome Powell with a more dovish successor. These developments – should they unfold in the least favorable manner – would likely make a left-tail, or downside, outcome all the more costly.

What’s at stake

Significant progress has been achieved in the Fed’s battle against inflation once they recognized, and corrected, their transitory blunder. But while headline inflation as measured by the Consumer Price Index (CPI) stands at 2.7%, sticky inflation – an amalgamation of categories that change slowly and account for roughly 70% of CPI – resides at a more worrisome 3.3%.

Within this context, the argument that the fed funds rate – at 4.5% – has considerable room to drop becomes more tenuous. Based on sticky inflation, the fed funds rate is already within striking distance of the level of inflation that matters. Targeting the lower – and noisier – headline could lead to consumer prices ricocheting, resulting in the second major miscalculation of this cycle.

An untimely convergence

The pandemic-era inflationary surge was ignited by supply-chain disruptions and then exacerbated by massive fiscal stimulus. The previously unforeseen impetus for a second wave of inflation could be supply disruptions brought forth by Trump’s trade war.

Meanwhile, a more dovish Fed in 2026 could release a credit impulse in the form of lower rates, potentially spurring demand even as global supply chains and pricing remain in flux. It should be noted that the Fed is governed by a committee, and switching chairs may not result in greater accommodation. But the rhetorical assault on the U.S. central bank is hard to ignore. The potential convergence of supply and demand pressures means both the kindling and matches necessary for a second wave are in place.

An error-driven second wave would back the Fed into a corner with no good choices. Keeping policy accommodative – for whatever the reason – would likely cement inflation expectations at unwanted levels, distorting the important mechanism of price signals across the economy. It would also destroy the Fed’s credibility. The lone alternative would be for the Fed to raise rates – as it was forced to do in the late 1970s and early 1980s – to levels that would almost certainly cause a steep economic downturn.

Source:Janus Henderson

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Glendon

Economic

Bond

Euro zone government bond yields were set to break a three-day losing streak on Wednesday, taking cues from U.S. Treasuries, while traders continued to price in a 90% chance of a European Central Bank rate cut by March 2026.

U.S. yields fell sharply on Friday after weaker-than-expected jobs data triggered a strong dovish repricing of Federal Reserve monetary cycle. They edged higher on Tuesday, even as economic data pointed to stalling activity in the services sector.

Germany's 10-year bond yield (DE10YT=RR), the benchmark for the euro zone, rose 2.5 basis points (bps) to 2.65%.

Benchmark 10-year U.S. yieldwas up 4 bps at 4.24% in London trade.

The yield gap between U.S. and German 10-year government bonds (DE10US10=RR) was at 159 bops after hitting 153.3 last week, its lowest level since early April.

“A stalling U.S. economy should lead to further Treasury outperformance and a smaller growth differential between the US and the euro area,” said Reinout De Bock, rate strategist at UBS, adding that he has a 135 basis point target.

“What could also help the trade, is that the bar for a September cut by the ECB seems high.”

Money markets priced in an around 60% chance of a rate cut by year-end (EURESTECBM3X4=ICAP) and an 80% chance of the same move by March 2026 (EURESTECBM5X6=ICAP).

Traders are pricing in a 90% probability of a 25-bp rate cut by the Fed in September, and a total of 125 bps of easing by October 2026.

“Given the inflation backdrop the Fed is in a tough spot. More evidence of labour market weakness is required for a move, but I guess that is what markets will possibly bet on now,” said Chris Iggo, CIO at AXA Core Investments.

“I sense expectations have changed on the U.S. economy’s near-term outlook. Recession risks have increased.”

Germany's two-year yield (DE2YT=RR) rose 1.5 bps at 1.91%.

Italy’s 10-year yieldrose 3 bps to 3.48%, with the spread versus Bunds to 82.5 bps. It hit 81.44 on Tuesday, its lowest since April 2010.

Analysts argued that with the ECB easing cycle close to an end, the air for a further BTP-Bund spread compression will probably become thinner after the summer.

They recalled that some technical factors could also fade. Positive ratings kicked off the tightening, but declining volatility favouring carry trades and lower supply over the summer have helped to extend the rally.

Source: Reuters

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Winkelmann

Commodity

Cryptocurrency

Forex

Economic

Key Points:

● Tom Lee foresees Bitcoin replacing gold.

● Institutional adoption may end Bitcoin cycles.

● Bitcoin projected to spike in value.

Tom Lee: Bitcoin's Rise and Institutional Adoption

Tom Lee, co-founder of Fundstrat Global Advisors, asserts Bitcoin is replacing gold and ending its four-year cycle, due to increasing institutional adoption and macroeconomic shifts.Lee's perspective suggests Bitcoin's growing legitimacy could transform global financial landscapes, potentially driving significant price appreciation, attracting investor interest, and impacting associated cryptocurrencies.

Lee cites Bitcoin's superior properties over gold, emphasizing its role in the financial market. Institutional interest is reportedly rising post-ETF approvals, driving a shift in Bitcoin's traditional boom-bust cycles, potentially altering its market dynamics.The forecast potentially impacts global markets, stirring interest among investors and policymakers. The demand and supply imbalance noted by Lee could drive up Bitcoin's value, affecting how governments and investors view cryptocurrency investments.

Financial implications include a prospective revaluation of Bitcoin's store of value, with the U.S. possibly integrating it into strategic reserves. Regulatory adaptations could bolster this shift, fostering comfort among institutional stakeholders and promoting further adoption.The potential growth of Bitcoin could affect related cryptocurrencies such as Ethereum and Solana. Lee anticipates significant price movements due to heightened institutional flows and network adoption patterns. The financial landscape may experience material shifts in asset valuation structures.

Historically, Bitcoin's four-year cycle has led to significant price upticks, but Lee predicts a new paradigm by 2025. As Bitcoin matures, backed by substantial institutional backing, it could surpass gold’s market cap, reshaping investment norms and asset management strategies. Lee remarked, "95% of all Bitcoin has been mined, but 95% of the world doesn't own Bitcoin. There's a huge demand versus supply imbalance."

Source: CryptoSlate

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Blue River

Technical Analysis

The New Zealand dollar continues to have a quiet week. In the European session, NZD/USD is trading at 0.5923, up 0.37% on the day. The kiwi has been under pressure, falling 3.4% against the US dollar in July.

New Zealand’s unemployment rises, job growth declines

New Zealand’s employment report for Q2 was pretty much as expected, but the news wasn’t good. The unemployment rate rose to 5.2% from 5.1% in Q1, below the consensus of 5.3%. This marked the highest unemployment rate since Q3 2020. Employment Change declined by 0.1%, down from a 0.1% gain in Q1 and matching the consensus. This was the third decline in four quarters.

The weak figures point to growing slack in the labor market as the economy continues to struggle. Global trade tensions remain high and New Zealand’s export-reliant economy has taken a hit from softer global demand.

The Reserve Bank of New Zealand will be paying close attention to the weak job numbers, which support a rate cut in order to provide a boost to the economy. The RBNZ maintained rates in July after lowering rates at six consecutive meetings. The conditions for a rate cut at the Aug. 20 meeting seem ripe and the markets have priced in a quarter-point reduction at around 85%.

We’ll get an updated look at the inflation picture on Thursday. Inflation Expectations rose to 2.3% in the second quarter, the highest in a year. This is the final tier-1 release prior to the August rate meeting.

Fed expected to cut in September

Three FOMC members will speak later today and investors will be hoping for some insights regarding the Federal Reserve’s rate plans. The Fed hasn’t lowered rates since December but is widely expected to hit the rate trigger at the September meeting.

NZD/USD Technical

NZDUSD 1-Day Chart, Aug. 6, 2025

NZD/USD has pushed above resistance at 0.5902 and testing 0.5922. Next, there is resistance at 0.5944
0.5880 and 0.5860 are providing support

Source: ACTIONFOREX

Risk Warnings and Disclaimers

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Glendon

Economic

Stocks

Stock bulls have another reason to worry that the blistering rally in American equities may be about to cool.

The Bloomberg Intelligence Market Pulse Index pushed to a “manic” reading last month, a sign that investor exuberance may be running too hot. The measure combines six metrics like market breadth, volatility and leverage to deliver a reading on investor sentiment. When it gets into overheated territory, returns tend to weaken in the following three months.

The Pulse index’s rise comes after the S&P 500 rallied almost 30% from its April low even as the American economy and labor market have shown signs of weakening. Surveys of investor sentiment indicate bullishness is growing toward alarming levels among Americans. And just this week, Wall Street strategists issued a slew of warnings that equities could face a pullback.

“Risk taking in the stock market has gotten a bit overheated, so more muted returns may be in store in the next few months,” Michael Casper, senior US equity strategist at BI, said by phone. “But this doesn’t necessarily signal a major selloff is imminent. Sentiment could hover at these levels for awhile, which may lead to a bumpier path for stocks in the second half of the year.”

The S&P 500 notched its worst week since May last week before dip buyers stepped in to deliver its best one-day gain since that same month. The index slipped 0.5% Tuesday.

BI’s Pulse index hit 0.6 in July for the second straight month to push it into the “manic” zone. Over the past 30 years, the Russell 3000 Index — a crucial benchmark of the virtually the entire US stock market — has averaged just a 2.9% return over the next three months, according to data compiled by BI’s Casper and Gillian Wolff. When the gauge swings into what BI dubs “panic” territory, the Russell 3000 averages a 9% gain in the next 90 days.

The index signal jibes with recent warnings from a host of Wall Street strategists. Morgan Stanley’s Mike Wilson sees a correction of up to 10% this quarter, while Evercore’s Julian Emanuel is expecting a drop of up to 15%. A team at Deutsche Bank notes that a small drawdown in equities is overdue.

Added to bulls’ worries is seasonality. August and September have historically been the two worst months for the S&P 500. Friday’s jobs report showed the labor market cooling, while a private reading on the American services sector on Tuesday signaled a slowdown in output and an increase in price pressures — all while President Donald Trump pushes ahead with tariffs that are the highest since 1934.

The Pulse index has been a reliable harbinger of market performance in recent years. The readings hit “panic” levels ahead of the March 2023 regional banking crisis, the December 2018 tariff-induced slide and the 2012 European Union debt crisis.

Among the reasons for the latest “manic” reading were was the re-emergence of the meme frenzy in late July, with retail traders snapping up speculative stocks like Opendoor Technologies Inc. and Kohl’s Corp.

Of course, sentiment can stay frothy for weeks — even months — before stocks suffer a significant drop. It hit a manic reading during January 2021’s meme craze but hovered in that territory for over a year before the S&P 500 slumped into a bear market.

Perma-bull Ed Yardeni of eponymous firm Yardeni Research noted that not all signs are ominious. In the week through July 29, a ratio of bulls to bears identified in an Investors Intelligence survey of newsletter writers hovered at a ratio of 2.4, below a long-term average of 2.6 over the past decade, Yardeni Research analysis shows.

“In other words, sentiment wasn’t overly bullish,” Yardeni wrote in a note to clients on Sunday. “Rather than yet another correction this year, we are more likely to see seasonal choppiness.”

BI’s Market Pulse Index is based on six inputs: price breadth, pairwise correlation, low-volatility performance, defensive-versus-cyclical performance, high-versus-low leverage performance and high-yield spreads. The major difference last month was that high-yield spreads were manic in July, joining high versus low vol performance in that territory.

The Market Pulse Index ranges from 0 to 1, with the latter denoting periods of risk-on sentiment, or extreme “mania,” as BI defines it, while a level close to 0 shows a risk-off period of extreme “panic.” In July, the indicator rose to nearly 0.7 — approaching a mania stage.

Generally, two repeat readings above 0.6, like now, suggests there will be some mean-reversion activity in the equity market over the next three months, with small caps underperforming their larger counterparts, according to Casper. In fact, three months after a manic reading, the small cap Russell 2000 Index historically has underperformed the S&P 500 by 1.8% after such a figure.

“Stocks have come a long way in a short time and things seem stretched,” said Adam Phillips, managing director of portfolio strategy at EP Wealth Advisors, whose firm is neutral US equities and is snapping up dividend-payers like energy, financial and industrial shares. “We’re not chasing this rally or stepping on the gas pedal.”

Source: Bloomberg Europe

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Gerik

Economic

Geopolitical Risk Reignites Market After Four-Day Decline

Crude oil rebounded midweek after a sustained decline, with Brent climbing back above $68 per barrel and West Texas Intermediate nearing $66. The rally follows speculation that U.S. President Donald Trump may impose secondary sanctions on nations continuing to buy Russian oil such as China and India in a bid to intensify pressure on Moscow.

The market reaction reflects growing sensitivity to geopolitical developments that may disrupt global trade flows. Trump’s rhetoric has already triggered diplomatic unease, and U.S. envoy Steve Witkoff’s arrival in Moscow for last-minute talks underscores the seriousness of the looming deadline. With just two days left before Trump's ultimatum for a ceasefire in Ukraine, oil traders are recalibrating risk scenarios that could limit Russian exports or provoke retaliatory trade restrictions.

OPEC+ Output Decision Fuels Oversupply Concerns

The upward momentum in oil prices is occurring alongside broader uncertainty surrounding supply. OPEC+ recently confirmed its decision to increase production again in September, continuing its gradual rollback of earlier output cuts. This policy shift has sparked concerns that global supply could once again outpace demand, particularly in the context of a weakening economic outlook in major consumer markets.

The decision by OPEC+ to proceed with production hikes despite price volatility reflects a broader strategy of supply normalization. However, this move, combined with the potential for weaker demand due to economic softening in the United States and Europe, may limit the sustainability of the current price rebound.

Soft U.S. Economic Data Adds Headwinds to Oil Demand Outlook

Macroeconomic indicators in the U.S. are also weighing on market sentiment. Recent data revealed stagnation in the services sector in July, adding to signals of a broader economic deceleration. These figures contribute to market fears that slowing domestic activity could reduce near-term energy consumption, weakening the demand side of the oil equation.

Despite geopolitical premiums, traders remain cautious given these economic indicators. Forward-looking market gauges suggest a loosening of supply-demand balance, with front-month contract spreads narrowing an indication that physical markets may be entering a softer phase.

Mixed U.S. Inventory Signals Keep Traders Wary

Data from the petroleum industry has provided a mixed view of short-term supply conditions. U.S. crude inventories reportedly fell by 4.2 million barrels last week, suggesting a drawdown in domestic stockpiles. However, inventory levels at Cushing, Oklahoma the primary delivery point for WTI futures rose, along with distillate reserves. These conflicting signals complicate interpretations of short-term tightness versus longer-term oversupply.

An official inventory report is expected later, which could provide additional clarity. Until then, the market remains volatile, with investors weighing multiple, and at times contradictory, inputs from policy, macroeconomics, and physical inventory trends.

Oil Market Caught Between Geopolitical Risk and Economic Softening

The rebound in oil prices underscores the market's acute responsiveness to geopolitical developments, particularly those involving U.S.-Russia tensions and global energy trade disruptions. However, this upside is tempered by growing concerns over macroeconomic weakness and rising production levels.

The causal link between Trump’s tariff threats and near-term price action is evident, though the longer-term impact remains contingent on enforcement, global diplomatic responses, and structural supply adjustments. Meanwhile, OPEC+ actions and U.S. economic indicators continue to serve as critical variables in determining whether this rebound is temporary or the beginning of a new upward trend.

Source: Bloomberg

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Michelle

Economic

Stocks

Asian shares were mostly higher in muted trading Wednesday, after discouraging signs about the U.S. economy sent Wall Street shares declining.

Investors are sifting through a slew of corporate earnings reports to assess how businesses may have been affected by U.S. President Donald Trump’s tariffs.

Among Japanese companies, automakers Honda Motor Co. and Toyota Motor Corp. will report fiscal first quarter results this week, as will electronics and entertainment company Sony Corp.

Japan’s benchmark Nikkei 225 rose 0.6% to finish at 40,794.86. Australia’s S&P/ASX 200 added 0.8% to 8,843.70. South Korea’s Kospi was little changed, gaining less than 0.1% to 3,198.14.

Hong Kong’s Hang Seng rose 0.2% to 24,958.75, while the Shanghai Composite gained 0.8% to 3,633.99.

U.S. futures were up 0.5%.

On Tuesday, the S&P 500 fell 0.5% to 6,299.19, coming off a whipsaw stretch where it went from its worst day since May to its best since May. The Dow Jones Industrial Average dropped 0.1% to 44,111.74, and the Nasdaq composite fell 0.7% to 20,916.55.

A weaker-than-expected report on activity for U.S. businesses in services industries like transportation and retail added to worries that Trump’s tariffs may be hurting the economy. But conversely such indicators raise hopes the Federal Reserve may cut interest rates. That along with a stream of stronger-than-expected profit reports from U.S. companies helped to keep losses in check. The S&P 500 remains within 1.4% of its record.

The pressure is on companies to report bigger profits after the U.S. stock market surged to record after record from a low point in April. The big rally fueled criticism that the broad market had become too expensive.

For stock prices to look like better bargains, companies could produce bigger profits, or interest rates could fall. The latter may happen in September, when the Fed has its next policy meeting.

Expectations have built sharply for a rate cut at that meeting since a report on the U.S. job market on Friday came in much weaker than economists expected. Lower interest rates would make stocks look less expensive, while also giving the overall economy a boost. The potential downside is that they could push inflation higher.

Treasury yields sank sharply after Friday’s release of the jobs report, and they haven’t recovered. The yield on the 10-year Treasury eased to 4.19% from 4.22% late Monday and from 4.39% just before the release of the jobs report. That’s a significant move for the bond market.

In energy trading, benchmark U.S. crude rose 57 cents to $65.73 a barrel. Brent crude, the international standard, added 64 cents to $68.28 a barrel.

In currency trading, the U.S. dollar edged up to 147.66 Japanese yen from 147.61 yen. The euro cost $1.1575, down from $1.1579.