US Strategy Weekly: Data Unfiltered

The main event for financial markets this week will be the Federal Reserve’s August 21-23 Jackson Hole symposium, where, on Friday, Chair Jerome Powell is due to speak on the economic outlook and central bank policy. Markets are on edge in anticipation of these remarks because the futures markets have already priced in at least two 25 basis point rate cuts this year. In short, the futures markets expect Powell and the FOMC to change their collective view from one that suggests tariffs present an inflationary risk to one that says the worst of the tariff impact is already priced in. Such a shift in outlook should be easy under normal circumstances; however, egos are involved in this decision. Therein lies the rub.

Politics and egos should not play a role in Federal Reserve policy or in Wall Street’s economic and fundamental forecasts; but they do, and that can be dangerous for investors. When we look at just the data, without a filter, we see room for the Fed to begin rate cuts in September.

July’s inflation data was mixed with headline CPI unchanged at 2.7% YOY and core CPI at 3.1% YOY, up from 2.9%. However, in both cases, the stickiest part of inflation was found in service sector prices and unrelated to tariffs. See page 3.

PPI data for finished goods in July was unchanged at 1.9% YOY and core finished goods prices rose 2.9% YOY, up from 2.7%. But it was the PPI final demand index at 3.3% YOY, up dramatically from 2.4% in June, that alarmed investors. This was a big jump, however, 3.3% merely matched the February 2025 level before tariffs were in place. Moreover, 30% of the July rise in PPI final demand could be traced to higher margins in services, in particular for machinery and equipment wholesaling. This jumped 3.8% YOY. Keep in mind that the Trump administration’s tariffs apply only to physical goods, not to services. 

When we broke down the final demand PPI 3.3% YOY into its main constituents we found that the PPI final demand for goods was 1.9% YOY (final demand foods rose 4.2% YOY, final demand energy fell 3.2%, final demand goods less foods and energy rose 2.8% YOY), final demand services was 4.0% YOY (final demand trade services 6.9%, final demand transportation and warehousing service 0.9%, final demand services less trade, transportation, and warehousing 3.1%), and final demand construction 1.1%. In short, just like in the CPI, the inflation seen in July originated from the service sector, not from tariffs.

Inflation numbers have not yet reached the Federal Reserve’s target of 2% YOY, and the deceleration seen earlier in the year appears to have stalled in July. Our concern is that the media’s obsession with tariffs and inflation has given the service sector an excuse to increase margins by raising prices. This is a problem for consumers. However, even after the upticks in July, all inflation benchmarks remain below the long-term average of 3.5% YOY and that is a positive.

Import prices, which are pre-tariff calculations, fell 0.2% YOY, the third consecutive month of declining import prices. Import prices excluding petroleum products were up 1% YOY, relatively unchanged from June. This implies that sellers to the US are keeping prices low and absorbing some of the administration’s tariffs. The Fed’s favorite benchmark, the PCE index, rose 2.6% YOY in June, up from 2.4% in May, but it too remains below the 2.7% YOY pace seen in February. Once again, there are little or no signs that tariffs have had an inflationary impact on the US economy to date. See page 4.

The Federal Reserve left interest rates unchanged in 2025 based upon the potential risk seen for a tariff-driven inflationary cycle. Several months ago, Chairman Powell cited inflation expectations as a sign of future inflation risk. However, consumer and economic surveys have proven to be very inaccurate due to an imbedded political bias. For example, in June according to the University of Michigan’s survey of consumers, the expected one-year change in prices was a 6% increase. When this number is broken down by political affiliation, the one-year median increase expectation for prices was 9.3% for Democrats, 7.3% for independents, and 1.5% for Republicans. In other words, not only are many, if not most surveys demonstrating a political slant, and a frightening outlook for inflation, but they have also been wrong. After discovering this bias, we have paid little or no attention to consumer sentiment surveys.

In our opinion, forecasters should focus on facts not feelings. The current effective fed funds rate is 4.33%. Inflation is presently between a low of 2.6% (PCE deflator) and a high of 3.1% (Core CPI). This means the real fed funds rate is in a range of 125 to 175 basis points. Assuming the worst of the tariff impact is behind us and that the real fed funds rate typically averages 100 basis points, the fed funds rate should be 25 to 75 basis points lower today. See page 5. This allows for a 25 to 50 basis point cut in September. Keep in mind that inflation and employment data for August will be released before the next FOMC meeting and new data should make the Fed’s policy decision easier to predict.

The National Association of Home Builders index backtracked slightly in August to 32 and remains well below the 50-point threshold, marking poor building conditions over the next six months. A lack of buyers boosted house inventories in July and the 9.8 months of supply of new homes has inspired builders to use sales incentives. Nonetheless, in July, housing starts rose 5.2% YOY, with gains seen primarily in multifamily units, which represent a lower priced alternative for many consumers. Multifamily starts rose 9.9% YOY. On the other hand, housing permits fell 2.6% YOY in July overall and fell 8.2% YOY in the multifamily sector. See page 6.

From a technical perspective, our 25-day up/down volume oscillator is at 0.98 this week and neutral. The last positive readings in this breadth indicator were the one-day overbought readings of 3.15 on July 3 and 3.05 on July 25. This followed the oscillator being overbought for 9 of eleven days in May during which it reached a high of 5.10 on May 16. The 5.10 reading was the highest overbought reading since August 18, 2022 which appeared shortly after the market rebounded from its June 16, 2022 low. This was very positive performance and characteristic of a bull market cycle. See page 9. However, despite the positive readings made in July, this indicator is yet to confirm the new highs made by the S&P 500 and Nasdaq Composite last week. To do so, the oscillator should record an overbought reading of 3.0 or higher for a minimum of five consecutive trading days. At present, this indicator suggests advancing volume has been weakening in August. The longer this disparity continues, the greater the risk is that equities experience a near-term pullback. For example, a rate cut in September could generate a sell-on-the news decline. However, from a longer-term perspective, we would view this as a buying opportunity. Earnings have outperformed expectations in the first two quarters, and we believe this will continue in the second half. In short, a good economy and good earnings supports equities.

Gail Dudack

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