SpenserLerner

PM & Head of Multi-Asset Solutions at Harbor Capital / Formerly JP Morgan Asset Management

[SpenserLerner @LernerSpenser]

@lord_fed I agree - arrogant and no humility for his past mistaken views, yet still seems to want to take a wrecking ball to the institution.

[James Seyffart @JSeyff]

NEW: Very interesting filing from Harbor Funds for 5 "Lab ETFs". They will focus on each of the following: Anthropic, Google Deepmind, Meta, OpenAI and SpaceXAI. They'll be actively managed funds that specifically target each firm's "ecosystem" of companies

[CoinDesk @CoinDesk]

NEW: Harbor Funds filed for 5 actively managed “Lab ETFs” focused on the ecosystems around Anthropic, Google DeepMind, Meta, OpenAI, and xAI/SpaceXAI.

H/t @JSeyff

[SpenserLerner @LernerSpenser]

Check out my interview with Gregg Greenberg from Nasdaq!

https://t.co/VG8YTCG7oN

[SpenserLerner @LernerSpenser]

Macro and Positioning Update: 09/02/2025

Fed easing likely begins in September, but we're skeptical that the Fed cuts as much as priced. Chair Powell flagged that risks are shifting toward the labor market but emphasized the Fed can “proceed carefully,” making sequential deep cuts far from assured.

Market action does not suggest the Fed is that far behind the curve as bond market inflation expectations are firmer, credit spreads tight, and nominal GDP running near 4.5%. Conditions argue against emergency easing, though slowing private sector job growth could force a quicker pivot if the unemployment rate rises further.

Trump’s attempt to remove FOMC Governor Cook highlights institutional risk. Even if legally blocked, such efforts erode credibility and add risk premia to rates and inflation expectations if markets begin to question the Fed’s willingness to target 2% inflation over time at the expense of politics.

Q2 earnings are almost entirely reported; S&P EPS came in at +11.5% YoY, with outsized beats from Big Tech and Financials masking low single digit growth from the remaining sectors.

Industrial rebound is still a 2026 story. Consumer spending is resilient after a soft H1 as high-frequency data remains firm, and monetary/financial indicators point to improvement in growth conditions. PMIs remain weak, but leading indicators suggest an eventual industrial upturn by 2026.

Fed Easing Cycle

Markets are confident a September rate cut is coming, which Powell’s Jackson Hole comments supported, but they also cautioned against assuming a rapid or continuous easing path. As he noted, “Our policy rate is now 100 basis points closer to neutral than it was a year ago, and the stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance.”

He also warned that the labor market’s current “curious kind of balance” masks rising downside risks: “If those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment.” Taken together, Powell leaned toward a cut in September but underscored that the Fed’s reaction function will be more data-dependent than a classic easing cycle. The 125 bps of cuts priced by markets over the next year appear aggressive relative to current conditions.

Risk of the Fed Falling Behind the Curve

While slowing payrolls highlight risks to growth and the labor market, financial market indicators suggest the Fed is not “behind the curve.” Bond market inflation expectations at the 5 and 10-year tenor (beyond tariffs) are higher than a year ago and even three months ago, credit spreads are tighter, and growth in the money supply has reaccelerated.

Nominal GDP proxies remain near 4-5% (Dallas Fed Weekly Index, Atlanta GDP Nowcast, breakevens and inflation swaps). This backdrop argues against emergency-style easing. There is risk to both inflation slipping away from the Fed and also labor market fragility if policy remains restrictive for too long. Investors should therefore expect a gradual easing trajectory.

Fed Independence

President Trump’s attempt to remove Fed Governor Lisa Cook highlights continued risk of Fed politicization. While the Supreme Court recently reaffirmed the Fed’s “unique structure” and high bar for dismissal of FOMC members, the effort raises questions about institutional independence. Even if unsuccessful, such maneuvers could inject volatility into rates and FX markets, as investors build in a risk premium.

Further, the more politicization markets anticipate, the more future inflation markets will assume as Fed interest rate policy may be driven by politics rather than price stability and low unemployment. Should another vacancy emerge on the FOMC, Senate confirmation dynamics act as a possible defense to any political sycophant being appointed; recall that historically nominees have been rejected by the Senate under both Trump and Biden. For markets, the headline risk is less about immediate policy shifts and more about eroding credibility and independence and which could lead to higher medium and long-term inflation expectations.

Q2 Earnings

With over 96% of S&P 500 market cap reported, Q2 EPS is up 11.5% YoY, revenue is up 6.1%, and 74% of companies are beating estimates. The heavy lifting came from the Tech+ cohort (EPS +27%), led by outsized beats from META (+38% EPS), AMZN (+33%), and NVDA (+54%). Financials also posted strong EPS growth (+20%). Cyclicals excluding energy barely grew, and energy contracted (-18%). Earnings expectations are picking up as NTM EPS estimates are rising again after falling in the midst of the tariff chaos in April and May.

Growth Conditions

Money growth is accelerating (+4.5% YoY vs. +1.4% a year ago), 5 and 10-year inflation expectations have moved higher, and the curve is now upward sloping—all consistent with improving growth conditions after the 1H slowdown.

Nominal GDP has been running close to ~4.5% with real GDP tracking 1.5% to 2.0% for Q3. Layoffs remain low and unemployment has ticked up recently but is still mostly flat over the last year. Tariffs remain a modest drag but not yet disruptive. We do expect tariffs to act as more of a headwind in the months ahead, but the underlying economy seems to be in a strong position to manage these headwinds.

Stalling consumer spending in H1 is now being followed by improvement in the July/August data. Redbook retail sales are strong (+6.5% YoY), OpenTable dining and TSA throughput confirm services resilience. Weakness has been concentrated in autos and travel, while tech, healthcare, and financial services spending is still firm.

Manufacturing PMIs remain sub-50, consistent with meager industrial activity. However, with money growth accelerating, the yield curve now upward sloping, the beginning of Fed rate cuts, cap ex and R&D tax incentives from the OBBBA and substantial aggregate AI infrastructure cap ex, the industrial cycle is likely to turn up in 2026 once the bulk of the rise in goods prices from tariffs is behind us.

Positive signals from the tape suggest growth remains firm and possibly reaccelerates sooner than originally anticipated:

- Homebuilder stocks are posting strong gains
- Russell 2000 has begun to outperform
- Consumer Discretionary stocks are reaching highs relative to Consumer Staples
- Bank stocks are reaching relative highs vs. the market
- The 10-2 U.S. Treasury yield curve is steepening (good if it happens along side tight credit spreads)
- 5-year real rates are falling, suggesting improving liquidity
- High yield spreads are at tights

[SpenserLerner @LernerSpenser]

Need to account for much higher profit margins, ROE and return of capital via buybacks and dividends today vs. history. These dynamics undermine the credibility of a simple time series valuation analysis. I think multiples are reasonable considering the enhanced fundamentals vs. history.

[SpenserLerner @LernerSpenser]

@MarkStein001 @lord_fed Well being a perma bull ends up being right most of the time!

[SpenserLerner @LernerSpenser]

Although tariff pass through has been pretty modest thus far, we expect core goods to accelerate further and core PCE to register around 3.3% by YE. Importantly, breakevens and inflation swaps beyond the one year horizon are anchored and point to around 2% inflation PCE (runs 40bps or so below CPI). Chair Powell also suggested in his last presser that a reasonable base case pointed to tariff inflation as one time. We therefore still expect a cut in September, but probably a hawkish cut aka not endorsing the 100+bps of cuts priced in. More in this post below.

[SpenserLerner @LernerSpenser]

Weekly Macro Update:

Key Takeaways:

Inflation is accelerating, but with the July CPI print less than feared due to moderate tariff pass through to goods prices, a September Fed cut is still likely, although not certain

Core goods prices have shifted from deflation to mild inflation, with services disinflation keeping overall PCE contained; the bigger tariff impulse to prices is expected to still show in August and September data

Recent Fed speak is mixed with Daly signaling openness to a September cut, citing labor market softening, while hawks like Musalem and Bostic remain resistant to easing for now

Q2 global earnings growth came in at 7.2%, above the long-term average for the sixth straight quarter, with the Mag-7 leading the charge as earnings grow 22%, driving U.S. earnings growth to 12%

Unlike during last year’s 50 bps September cut following the summer growth scare, inflation expectations currently are stable rather than falling, the unemployment rate is relatively flat YTD vs. rising last year, and financial conditions are growth-friendly vs. tightening last summer; thus, the decision to cut is much less clear this time around, though we still think a 25bps September cut is likely

The Fed has room to maneuver, inflation is behaving just well enough to allow for a cautious cut, and earnings momentum suggests the corporate sector can handle a slower growth path this year (particularly with tech + earnings trends). Markets are likely to continue climbing the “wall of worry” but its also too early to declare victory on tariff inflation

July CPI, PPI, what it means for PCE and tariff inflation

The July CPI report was close to expectations with core CPI rising 0.32% month-on-month. Goods inflation was modest, with core goods ex-autos up 0.2%, but supercore inflation (services excluding rents) accelerated to a 3.1% annualized rate, up from 0.7% in April. This reflects solid wage growth (~4%) and price pressures in categories like recreation and medical care. The level of supercore inflation is not alarming on its own as historically services inflation runs above 2% and goods inflation runs below 2%, but when combined with rising goods inflation from tariffs, the overall inflation level is likely to continue rising into year-end and settle out somewhere close 3.3% on core PCE.

Tariff effects are showing up but remain fairly muted so far. Core goods deflation has flipped to mild inflation, and while we expect a bigger hit to inflation to still come (especially in back-to-school goods), the Fed still sees these as one-time level shifts, not sustained inflation drivers, as Powell stated in his last press conference. July PPI data reinforced the view that tariff inflation is still percolating with core goods up 0.38% from notable pressures in tariff-exposed sectors. July core PCE estimates now stand around 0.3%, pointing to ~2.9% y/y core PCE inflation growth through July.

Recent Fed Speak

Fedspeak has tilted dovish since the weak July payrolls print. San Francisco’s Mary Daly openly noted the case for easing is “nearing,” and Governor Lisa Cook expressed concern about the labor market. Powell noted in his latest presser that tariff impacts are likely temporary, giving the Fed flexibility. Still, not all are convinced; Neel Musalem's comments suggest a hawkish bias, and Atlanta’s Raphael Bostic remains at just one cut for the year.

Market pricing implies ~95% odds of a September cut, we think a cut is likely but acknowledge the possibility that a hot August inflation print and/or strong August payroll print could reduce the chances. Importantly, the tone at the September press conference will also be key. A "hawkish" cut talking down the additional cuts priced through the end of 2026 would likely strengthen the USD, lead to higher rates and quell the on-again-off-again reflation trade of recent months. Unlike during the 2024 mini cutting cycle, the Fed is navigating an economy with stable and contained inflation expectations, flat unemployment albeit July's unemployment report up-tick, and accommodative financial conditions—suggesting less clarity around the magnitude of the upcoming cutting cycle.

September Fed Meeting

The Fed will weigh:

Growth: Below potential but still positive

Labor: Job growth below breakeven in recent prints but no surge in unemployment or firings

Inflation: Slightly hot services ex rents in July, but modest goods pressures from tariffs so far

Inflation Expectations: Markets are pricing a rise in inflation to 3.0-3.5% over the next 12 months, but then a steady fall back to the Fed's 2.0% target; consumer surveys point to anchored inflation expectations

Our base case: a 25 bps cut in September signaling willingness to support the cycle without endorsing the 100+ bps of easing currently priced in. The Fed’s tone will likely aim to keep inflation expectations anchored while addressing softening in the labor market. This base case may change per August inflation and payroll data.

Q2 Earnings Recap

Q2 global earnings have risen 7.2%, the sixth consecutive quarter above the long run 5.4% average. The U.S. is leading (+12%), with the Mag-7 growing 22% and still outpacing the S&P 493, though the latter did manage to post 9% growth. Sales growth in the U.S. also remains strong with revenues growing 6% in the quarter despite slowing consumer spending. Europe (-2%) is lagging but still managed to beat estimates by 3%, though falling short of the U.S. which beat estimates by an impressive 9%. Japan (-5%) was dragged down by auto tariffs and a stronger yen, while emerging markets (+8%) benefited from strong results in Brazil, India, and China. This broad earnings strength supports the case for continued economic expansion into year-end with notable strength in the U.S. and emerging markets.

Growth Outlook

Domestic final sales (GDP less inventories and net exports), which we believe to be a better measure of underlying growth momentum rather than headline GDP as it excludes volatile components, is expected to grow close to 0% in H2 2025, with headline GDP growth closer to 1.5% driven largely by net trade and inventory restocking. The Dallas Fed Weekly Economic Index suggests that economic momentum is holding with a current real GDP reading of +2.6%. Further, small business optimism has recently risen, and credit conditions remain easy and supportive. Fiscal tailwinds in 2026 and gradual Fed easing should help steepen yield curves, anchor volatility and drive stronger following the current below potential growth spell that is expected to last through the end of the year. We think the unemployment rate may tick higher in the coming months as tariff inflation further bites real spending and drives domestic final sales to below trend, but overall we expect resilient growth and labor market conditions.

Importantly, due to strong secular trends within the tech + cohort of U.S. equities and a weakening USD, corporate earnings growth has continued to grow at a very strong pace despite economic growth running below trend so far this year. As long as tech + trends remain intact, particularly for the Mag-7, and the labor market does not succumb to non-linear recessionary softening, then the S&P 500 can continue to climb the "wall of worry."

[SpenserLerner @LernerSpenser]

Weekly Macro Update:

Key Takeaways:

Inflation is accelerating, but with the July CPI print less than feared due to moderate tariff pass through to goods prices, a September Fed cut is still likely, although not certain

Core goods prices have shifted from deflation to mild inflation, with services disinflation keeping overall PCE contained; the bigger tariff impulse to prices is expected to still show in August and September data

Recent Fed speak is mixed with Daly signaling openness to a September cut, citing labor market softening, while hawks like Musalem and Bostic remain resistant to easing for now

Q2 global earnings growth came in at 7.2%, above the long-term average for the sixth straight quarter, with the Mag-7 leading the charge as earnings grow 22%, driving U.S. earnings growth to 12%

Unlike during last year’s 50 bps September cut following the summer growth scare, inflation expectations currently are stable rather than falling, the unemployment rate is relatively flat YTD vs. rising last year, and financial conditions are growth-friendly vs. tightening last summer; thus, the decision to cut is much less clear this time around, though we still think a 25bps September cut is likely

The Fed has room to maneuver, inflation is behaving just well enough to allow for a cautious cut, and earnings momentum suggests the corporate sector can handle a slower growth path this year (particularly with tech + earnings trends). Markets are likely to continue climbing the “wall of worry” but its also too early to declare victory on tariff inflation

July CPI, PPI, what it means for PCE and tariff inflation

The July CPI report was close to expectations with core CPI rising 0.32% month-on-month. Goods inflation was modest, with core goods ex-autos up 0.2%, but supercore inflation (services excluding rents) accelerated to a 3.1% annualized rate, up from 0.7% in April. This reflects solid wage growth (~4%) and price pressures in categories like recreation and medical care. The level of supercore inflation is not alarming on its own as historically services inflation runs above 2% and goods inflation runs below 2%, but when combined with rising goods inflation from tariffs, the overall inflation level is likely to continue rising into year-end and settle out somewhere close 3.3% on core PCE.

Tariff effects are showing up but remain fairly muted so far. Core goods deflation has flipped to mild inflation, and while we expect a bigger hit to inflation to still come (especially in back-to-school goods), the Fed still sees these as one-time level shifts, not sustained inflation drivers, as Powell stated in his last press conference. July PPI data reinforced the view that tariff inflation is still percolating with core goods up 0.38% from notable pressures in tariff-exposed sectors. July core PCE estimates now stand around 0.3%, pointing to ~2.9% y/y core PCE inflation growth through July.

Recent Fed Speak

Fedspeak has tilted dovish since the weak July payrolls print. San Francisco’s Mary Daly openly noted the case for easing is “nearing,” and Governor Lisa Cook expressed concern about the labor market. Powell noted in his latest presser that tariff impacts are likely temporary, giving the Fed flexibility. Still, not all are convinced; Neel Musalem's comments suggest a hawkish bias, and Atlanta’s Raphael Bostic remains at just one cut for the year.

Market pricing implies ~95% odds of a September cut, we think a cut is likely but acknowledge the possibility that a hot August inflation print and/or strong August payroll print could reduce the chances. Importantly, the tone at the September press conference will also be key. A "hawkish" cut talking down the additional cuts priced through the end of 2026 would likely strengthen the USD, lead to higher rates and quell the on-again-off-again reflation trade of recent months. Unlike during the 2024 mini cutting cycle, the Fed is navigating an economy with stable and contained inflation expectations, flat unemployment albeit July's unemployment report up-tick, and accommodative financial conditions—suggesting less clarity around the magnitude of the upcoming cutting cycle.

September Fed Meeting

The Fed will weigh:

Growth: Below potential but still positive

Labor: Job growth below breakeven in recent prints but no surge in unemployment or firings

Inflation: Slightly hot services ex rents in July, but modest goods pressures from tariffs so far

Inflation Expectations: Markets are pricing a rise in inflation to 3.0-3.5% over the next 12 months, but then a steady fall back to the Fed's 2.0% target; consumer surveys point to anchored inflation expectations

Our base case: a 25 bps cut in September signaling willingness to support the cycle without endorsing the 100+ bps of easing currently priced in. The Fed’s tone will likely aim to keep inflation expectations anchored while addressing softening in the labor market. This base case may change per August inflation and payroll data.

Q2 Earnings Recap

Q2 global earnings have risen 7.2%, the sixth consecutive quarter above the long run 5.4% average. The U.S. is leading (+12%), with the Mag-7 growing 22% and still outpacing the S&P 493, though the latter did manage to post 9% growth. Sales growth in the U.S. also remains strong with revenues growing 6% in the quarter despite slowing consumer spending. Europe (-2%) is lagging but still managed to beat estimates by 3%, though falling short of the U.S. which beat estimates by an impressive 9%. Japan (-5%) was dragged down by auto tariffs and a stronger yen, while emerging markets (+8%) benefited from strong results in Brazil, India, and China. This broad earnings strength supports the case for continued economic expansion into year-end with notable strength in the U.S. and emerging markets.

Growth Outlook

Domestic final sales (GDP less inventories and net exports), which we believe to be a better measure of underlying growth momentum rather than headline GDP as it excludes volatile components, is expected to grow close to 0% in H2 2025, with headline GDP growth closer to 1.5% driven largely by net trade and inventory restocking. The Dallas Fed Weekly Economic Index suggests that economic momentum is holding with a current real GDP reading of +2.6%. Further, small business optimism has recently risen, and credit conditions remain easy and supportive. Fiscal tailwinds in 2026 and gradual Fed easing should help steepen yield curves, anchor volatility and drive stronger following the current below potential growth spell that is expected to last through the end of the year. We think the unemployment rate may tick higher in the coming months as tariff inflation further bites real spending and drives domestic final sales to below trend, but overall we expect resilient growth and labor market conditions.

Importantly, due to strong secular trends within the tech + cohort of U.S. equities and a weakening USD, corporate earnings growth has continued to grow at a very strong pace despite economic growth running below trend so far this year. As long as tech + trends remain intact, particularly for the Mag-7, and the labor market does not succumb to non-linear recessionary softening, then the S&P 500 can continue to climb the "wall of worry."

[SpenserLerner @LernerSpenser]

Weekly Macro Update: Please follow to receive my weekly update that addresses macro, markets and positioning across multi-asset portfolios.

“We expect to see goods prices to start ticking up over the summer as tariffs take effect, and we have seen pauses in CapEx and hiring amongst our client base. All of that said, the strength of the US economy, driven by the American entrepreneur and a healthy consumer, has certainly been exceeding expectations of late.” - Jane Fraser, CEO of Citigroup

“After the initial shock of tariff policy changes, everyone kind of went on hold. But as we’ve noted in our comments a few times today, at a certain moment, you just have to move on with life, and it does feel like some of that is happening just because you can’t delay forever.” - Jeremy Barnum, CFO of JP Morgan

"Rates are at a good level for us. Deal activity is high. Capital markets are very strong. Consumer credit is excellent. Wholesale credit is excellent." - Jeremy Barnum, CFO of JP Morgan

US banks struck a mostly optimistic tone related to the consumer and economy during Q2 earnings calls.

Key Takeaways:

Despite softening payroll growth, the Fed does not see labor market slack picking up due to reduced immigration lowering the breakeven employment growth rate. This divergence from market expectations led to a post-FOMC rally in the dollar and bond sell-off.

A sharp drop in immigration and foreign born workers are constraining labor supply; the result is slower hiring, stable unemployment, and wage pressures—creating a stable but potentially softening labor market.

Initial jobless claims remain near lows and nominal income growth is still strong at ~5%, supporting consumer spending... but hiring weakness and downward payroll revisions signal mounting fragility beneath the surface.

The Fed's forecast of two 2025 rate cuts assumes unemployment rises to 4.5%. If that doesn’t materialize—and inflation rises from tariffs—those cuts may not come, increasing the risk of a policy misstep.

Seasonal weakness, stretched positioning in systematic strategies, and low liquidity in August/September raise the risk of market volatility. The base case remains a soft landing achieved through future rate cuts, but some caution is warranted in the short term as payroll growth slows. Pull-backs are to be bought.

Did the Fed just derail...or delay...the rally?

Chair Powell's latest FOMC press conference provided some interesting and consequential insights. Chair Powell and the committee seem to be focusing predominantly on the unemployment rate as the primary measure of labor market slack. This is important because non-farm payroll growth has slowed meaningfully this year, but so too has the growth in the labor force, thus resulting in a steady unemployment rate. The market has largely viewed this as reflective of broader softening in labor market conditions and supported the five cuts priced into bond markets through the end of 2026. The Fed, as Chair Powell articulated, sees it differently.
The Fed believes that given the significant decline in immigration from the administration's border and immigration policies, labor market growth has fallen substantially and thus the breakeven rate for employment growth (the monthly growth in payrolls required to keep the unemployment rate flat given natural population growth) has fallen. Just 12 months ago the breakeven payroll growth rate was believed to be around +100k jobs per month, perhaps even more. Currently, breakeven job growth is estimated to be around 70k jobs per month, or perhaps even lower.

This perspective suggests that the Fed thinks the slowing in payroll growth this year is not indicative of labor market softening and is therefore hawkish relative to expectations. The USD immediately rallied and rates sold off following the press conference.

The Fed is probably right and we are likely to continue down this path of generally lower hirings (lower NFP growth) and low firings (low initial jobless claims). The metric more indicative of consumer health than even hirings, however, is overall nominal income growth (the gross income growth to consumers when accounting for employment growth, growth in hours worked and growth in wages). Nominal incomes are still running around +5% yearly growth, suggesting that the spending power of the consumer is still in a good place. Further, the four-week average of initial jobless claims is running 2% below the trailing three-year average level this time of year, and 6% below year-ago levels, suggesting low firings and low recession risk. And, of course, the unemployment rate, which has been steady for the last year, currently sits at 4.2%.

The FOMC's dot plot which shows two cuts this year also forecasts the unemployment rate rising to 4.5%. If that unemployment rate forecast is not met, as inflation rises into year-end from tariffs, we may not see two commensurate policy rate cuts as previously anticipated.

The labor market, recession risks, and the dog days of summer

The July non-farm payrolls report was modestly disappointing, advancing 73k m/m jobs in July relative to the 106k jobs growth expected, with private payrolls rising by 83k. Most disappointingly, however, was that May and June payrolls were revised down by -258k jobs, resulting in a three-month average payroll gain of 35k and a three-month average private payroll gain of 52k. Notably, the last time we saw this level of weakness in job growth (summer of 2024), 100bps of Fed rate cuts ensued. However, at that time, inflation was trending down and initial jobless claims were trending up. This time around, that is in reverse as tariffs are driving core-goods inflation higher and initial jobless claims are at lows pointing to minimal firings. The unemployment rate also rose from 4.12% to 4.25% and has remained stable over the last year as both job growth and labor force growth have slowed. Lastly, YoY wage growth rose to +3.9%, at the high end of the 3.5% to 4.0% preferred range for the Fed.

The flat unemployment rate over the last 12 months and very low initial jobless claims point to low recession risk. Without firings, we will not see the unemployment rate rise at least 2-3% as is usual in typical recessions - and, as of now, there are minimal firings. However, there seem to also be few new hirings in recent months. So what gives?

We believe we're seeing a combination of two events drive this current labor market dynamic: 1) businesses managing through rising tariff costs and tariff uncertainty, and 2) labor-supply shock. During Covid, we experienced a goods-supply shock as manufacturing plants were shut down and ports were not shipping enough goods to meet demand. This resulted in lower growth and higher inflation. Now, we are experiencing a labor-supply shock as immigration has slowed from the unusually elevated level over the last several years of around three million annualized immigrants, most of which entered the labor force, to about 500k annualized currently. This sudden stop in the flow of labor due to policies of the new administration has two effects: 1) slows growth and spending, and 2) raises wages.

We believe that in the midst of the uncertainty around tariff negotiations and rising costs, businesses have slowed hiring but are not outright firing employees. This has probably accelerated the slowdown in hiring over the last few months. Further, as immigration policies slow the growth in the labor force, it is natural that fewer employees are also available to be hired which thus puts downward pressure on job growth.

The Trump administration has also ended the Temporary Protected Status program which allowed foreign nationals to live and work in the US on a temporary basis. This program has north of one million formerly legal residents that will no longer be able to legally work. Additionally, reports continue to cite that illegal immigrants have been self-deporting since Donald Trump's election victory with up to one million people leaving the country this year. The implication of these policies and the overall slowing in migration can be seen in the July Household Survey employment report which declined by -260k, led by a -400k decline in foreign born employment, which points to immigration as the primary driver of slowing payroll growth. Moreover, government job growth continues to slow as well. All of this to say that the labor market is going through an adjustment period that is suppressing monthly job growth numbers and reducing the equilibrium job growth needed to maintain the unemployment rate. This suggests that the economy is not falling apart, but rather experiencing a labor market supply shock and rebalance accompanied by some cyclical slowing.

While it is possible that this adjustment period results in low monthly jobs growth for a period of time without recession commensurate with nominal income growth around 5%, it also makes the labor market more fragile as it does not take much of a pick-up in firings for job growth to turn negative. Thus, although initial claims and the unemployment rate point to low recession risk, we do think the fragility in the labor market has risen and this could lead to a growth scare in markets. If the Fed responds to this dynamic by beginning another cutting cycle in September, then we would anticipate a soft landing and a reacceleration in 2026. If the Fed refuses to cut as goods inflation rises, then we may see some volatility in markets over the coming months.

Further, as we exit the seasonally strong June and July months, we now enter the seasonally weak August and September months where market liquidity is low. Additionally, although broader positioning does not seem euphoric or stretched, positioning from systematic investment strategies such as vol-targeting and trend following managers is reaching very long levels for equities. This matters as systematic strategies tend to amplify market moves, especially in the low liquidity tail of summer. This suggests that any negative fundamental news that triggers a volatility event will likely be further amplified to the downside than usual given systematic positioning and low liquidity.

Our base case from here acknowledges the rising risk of a growth scare in the coming weeks and months that could be amplified by low liquidity and very long equity positioning from systematic strategies, but that the Fed will ultimately cut interest rates and accommodate a soft landing which will lead to a reflationary backdrop later this year and/or in 2026. Therefore, any correction should likely be bought, barring a significant shift in fundamentals for the AI boom, the Fed or the labor market.

[SpenserLerner @LernerSpenser]

@lord_fed Some great calls. #Respect

[Capital Flows @Globalflows]

Liquidity, Positioning, and the Invisible Narrative Beneath FOMC - https://t.co/y8LNxYXrJg https://t.co/BHQWwZ5IAT

[SpenserLerner @LernerSpenser]

@lord_fed It’s only funny because it’s true

[SpenserLerner @LernerSpenser]

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Key Takeaways:

- Resilient Services; Manufacturing Set to Recover in 2026: Low initial jobless claims data and consumer income growth suggest low recession risk, even as the S&P manufacturing PMI softens temporarily due to tariff front-running. Manufacturing is expected to rebound in 2026, driven by permanent tax incentives, AI capex, and rising European defense outlays.

- Global Fiscal Expansion Persists: Major economies including the U.S., EU, China, and Japan are engaged in simultaneous deficit spending. Japan’s political shift from recent elections towards opposition parties that favor tax cuts and social spending reinforces this global fiscal dominance, leading to resilient growth but complicating efforts to return inflation to 2%.

- Markets Reflect Reflationary Outlook: Equity rallies in South Korea, U.S. capital goods, and rising copper prices alongside tight credit spreads signal investor expectations of a reacceleration in global manufacturing and capital spending ahead.

- U.S. / Japan Tariff Deal Reduces Trade Uncertainty: A new U.S.-Japan tariff agreement and an impending U.S.-EU deal mark progress in resolving trade tensions. With tariffs expected to stabilize around 15–17%, consensus now expects a non-recessionary growth slowdown and one-time price increase from tariffs with reaccelerating growth and disinflation thereafter in 2026.

Services resilient; manufacturing recovery in 2026?:

I've been talking recently about the reflationary signature we're seeing in markets. With the Kospi up 33% YTD, U.S. capital goods companies up 22%, copper up 13% and credit spreads ay cycle tights, markets are suggesting a rebound in manufacturing is likely ahead. With non-seasonally adjusted initial claims running 5% lower than this time last year and nominal incomes generated by the consumer running at a +5% rate from a year ago, the consumer seems to be fine. This is further supported by the S&P Global preliminary US services PMI for July which came in at 55.2 vs. 53.0 forecasted and 52.9 previously. Recession risk, therefore, remains low.

The US manufacturing PMI, however, was less positive, coming in at 49.5 and falling from the prior 52.9 and forecasted 52.7. Commentary from S&P highlighted that the manufacturing decline was "linked to a fading boost from tariff front-running." Recall the negative real GDP print for the first quarter? At the time we discussed how much of this was driven by an attempt to front run tariffs by boosting imports. This stimulative burst of activity will likely reverse in the 2H and create somewhat of a headwind to global manufacturing (as witnessed in July's PMI). Despite the manufacturing blip from the S&P Global PMI, we have seen other survey activity suggesting that the headwind is minimal and manufacturing momentum may actually be picking up with the Philadelphia Fed and Empire State surveys both surprising to the upside. Our proprietary manufacturing growth models suggest to us that the manufacturing cycle is meandering along for now, neither accelerating nor collapsing.

We believe manufacturing activity will probably remain choppy in the coming months as excess inventories are worked off from tariff front-running and tariff-driven inflation slows real spending. However, we also believe this will be followed by a reacceleration in both consumer spending and manufacturing in 1H of 2026. For manufacturing specifically, 100% bonus depreciation and immediate expensing for domestic R&D, which have both been made permanent, AI capex growth in 2026 estimated to be around 0.5% of GDP according to the tech consultant Gartner, and growth in German/European defense spending are all likely to kick start a capital spending boom. This is why, we believe, markets have been trading with a reflationary impulse of late as they look ahead to reacceleration in 2026.

Japanese elections - another sign of fiscal dominance:

The Upper House election outcome in Japan this past week resulted in the ruling coalition losing its majority after losing the Lower House earlier this year. Prime Minister Ishida has stated that he plans to remain in his position, but the ruling coalition will now have to cooperate with opposing parties to pass legislation.

Why am I going into the weeds on Japan's congressional election results? Because the opposition parties are almost universally supportive of consumption tax cuts and increasing social security benefits. This points towards a more expansionary fiscal dynamic in Japan going forward.

Couple this with increasing deficit spending from Germany and the EU on defense, 6.0% to 7.0% deficit spending in the U.S. persisting with the passage of the OBBBA, and China's 2025 deficit spending target of 4.0% of GDP (up from 3.0% in 2024), and you have the world's largest economies maintaining a policy of simultaneous deficit spending.

The implications: 1) continued growth resilience (recessions are hard to come by when governments spend this much), 2) it will be challenging for inflation to settle back to 2.0%, and 3) higher term premia and steeper sovereign curves.

Marking to market tariffs and trade:

The US and Japanese governments announced a tariff agreement that reduces tariffs on Japanese autos and auto parts from 25% to 15%, increases the reciprocal tariff from 10% to 15%, and includes a $550B investment in the US. This is positive for Japan as the impact of the reduced auto tariffs outweighs the higher reciprocal tariff and thus GDP estimates for Japan have risen by roughly 0.2% this year.

There are essentially five trading relationships that cover nearly 70% of US imports and matter most for trade deals: China, EU, Canada, Mexico and Japan. With China and Japan now behind us, and assuming Canada and Mexico remain USMCA exempted, the EU is the last critical trade partner of the U.S. that warrants a deal to move past the bulk of outstanding trade uncertainty.

Importantly, the media reported this past week that the U.S. and EU are on the verge of a trade deal that will leave tariffs at 15%, far below the threatened 30% several weeks ago. We believe the markets would view this favorably. While sector tariffs remain uncertain, it looks like the effective tariff rate increase will settle out in the 15% to 17% range for the foreseeable future. We expect core PCE inflation to rise to the 3.0% to 3.3% range by year-end and growth to slow to around 1.5% this year as a result. While seemingly problematic, markets already priced this with a 19% S&P 500 drawdown earlier this year and a resetting of expectations for a non-recessionary slowdown and transient one-time price increase peaking by year-end and then beginning to fade thereafter.

[SpenserLerner @LernerSpenser]

22/ expect long run PCE inflation to run close to 2% and the tariff boost will be short lived.

[SpenserLerner @LernerSpenser]

1/ Hated rallies persist until they're loved. This rally might be one of the most hated rallies in recent memory, second perhaps only to the 2023 rally following the Fed's aggressive hiking cycle and banking crisis.

[SpenserLerner @LernerSpenser]

21/ months (around the level of consensus economist expectations), but then quickly fall back to 2.5% in the following year and stay around that level thereafter. Recall that CPI tends to run approximately 0.4% higher than PCE, which suggests that markets