July 2025 Commentary and Economic Outlook
- InfraCap Management
- 5 days ago
- 8 min read
JULY 2025 EDITION:
Commentary and Economic Outlook
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 | Stock Market: |
Our year-end S&P Index target is 6,600 with risk to the upside due to optimism about AI implementation. We are optimistic about a July rally as we expect strong earnings aided by a weak dollar, which is down 6% Y/Y. We are likely, however, to have the normal pull back in the seasonally weak August/Sept. period. We view the Tariff Tantrum as an overreaction to the surprise tariffs as imports are only 10% of the US economy and the pass-through percentage is less than 50%.
The job market is starting to contract with the best leading indicator, continuing claims, rising to over 1.96 million, which is the highest level since the Pandemic.
The OBBBA is not a budget buster despite talking points to the contrary as the budget impact relative to current law is actually an annual reduction in the deficit of $100 billion per year with another up to $150 billion coming from higher tariffs. Even before these reductions, the budget deficit is projected to decline from $1.4 trillion or 6.5% of GDP to $1.7 trillion or 4.5% in fiscal 2026.
We do not expect a US recession as the economy is supported by the fact that the bond market has cut long-term rates for the Fed, which has kept housing starts at the 1.4MM annual rate. Oil prices have dropped over 10% this year and tech spending is likely to remain strong. The current proposed tariff increase will generate less than $170 billion in tax revenue which is only .5% of GDP and less than the benefit of lower energy prices for the US consumer. In addition, tech spending is offsetting the weakness in construction and residential. We forecast lower US growth in the 2% area, which is below long-term potential growth above 3% as tight monetary policy continues to weight on residential and construction investment.
The “Hatfield Rule” is a recession indicator which states that if housing starts drop below 1.1MM there will be a recession. It is superior to the “Sahm” rule as housing is a leading indicator and employment is a lagging indicator.
The Trump administration’s tariff policy is deeply unpopular on a bipartisan basis as is true with most tax increases. Only 39% of voters approve of the Administrations tariff policy vs. 49% approving of immigration policy. According to betting sites, the probability of Democrats regaining the House recently rose to 75% from 70% at the beginning of the President’s term and the probability of the Senate going to the Democrats rose from 20% to 25%. Its unclear that tariff revenue can be utilized to fund tax cuts in the reconciliation process. Betting odds have proven to be a superior predictor of elections than polls.
The US is the biggest currency manipulator in the world as its enormous budget deficits cause US rates to be among the highest in the world, which drives the dollar significantly higher and results in large trade deficits. Most investors do not realize that trade flows must balance financial flow, so any country that needs to borrow from overseas will necessarily have a large trade deficit.
| Bond Market: |
CPI printed cool at 0.2% on core vs. expectations of 0.3%. Headline was in line at 0.3% with food inflation higher. This CPI print implies that PCE core will come out at 0.23%. Tariffs continue to have no significant impact on CPI and even if they did, it should be ignored for the purposes of formulating monetary policy as an increase from tariffs is one time and, therefore, creates no ongoing inflation.
Using Zillow and Apartment list shelter data, our CPI-R index is up 1.2% Y/Y and real time PCE is at only 2.0%.
The Fed is now highly political with the 5 democrats on the Federal Reserve Board continuing to site tariffs as a risk to inflation despite overwhelming evidence to the contrary. Moreover, tariffs are a one time increase that should be ignored for the purpose of setting monetary policy. The two Republicans on the Fed Board have called for a July cut. We disagree with Peter Navarro’s op-ed that stated that Powell is the worst Fed Chair of all time as we only think he is the worst since WWII as Eurgene Meyers was worse as he shrunk the monetary base during the great depression.
We reiterate our StagDeflation call as the 2 critical drivers of inflation are the money supply and oil prices. We estimate that headline inflation will not be significantly impacted by tariffs as manufacturers are absorbing a large portion of the tax and imports affect less than 10% of CPI. In addition, declining money supply (down 9% Y/Y) and normalizing shelter inflation offset the small increase from tariffs. Oil prices are still down 10% on the year, despite volatility related to the war in the Middle East. Recent inflation data has continued to decline with last 3 months annualized core CPI coming in at 1.6%, core PPI coming in at .8%, and PCE Core coming in at 1.7%.
The “expectations theory” of inflation is archaic and has been discredited by recent research. We treat survey-based information on inflation as an endogenous factor that should not be used for forecasting.
We continue to be bullish on Treasury bonds, despite the recent sell-off with a 3.75% year-end yield target on the 10-year. The best cure for higher rates as rates over 4.5% on the 10-year imply a 30 year mortgage rate over 7%, which will cause the housing market to further slow. The economy is slowing (see details below) and weakness in the US job market will likely force the Fed to cut 2-3 times this year. Importantly, 2 members of the 7 member Federal Reserve Board have come out for a July rate cut. The market had failed to recognize that tariffs are recessionary / deflationary as the tax revenue reduces the deficit.
We expect a dovish pause in rates in July and a cut in September as 2 crucial members of the Reserve Board out of 7 have come out for a July cut. Powell will need to change his hawkish tone to appease those members.
We attribute the rise in the US 10-year from 4.16% on April 30 to as high as 4.6% due to the meltdown in the Japanese bond market with the JGB 10-year trading from a yield of 1.14% to the current 1.57%, which is a 17-year high and up from zero in late 2019. The crash in the JGB market is driven by the end of Japan’s hyper-loose monetary policy with the Japanese money supply shrinking by 4.8% Y/Y vs. a peak growth rate of 24% in mid-2021.
The Moody’s downgrade is irrelevant as there is no default risk for US Treasuries and the downgrade provided no new information about US debt or deficits.
US 10-year bonds are 65% correlated to the expected terminal Fed Funds rate and 25% correlated to global bonds. The budget deficit is relatively static and has been in the 5% of GDP range for years, so not a driver of interest rates in the short to medium term.
The current Fed policy framework is very dangerous and needs to be reformed. Specifically, it slavishly follows an index that trails real time market inflation by two years, resulting in the Fed being constantly behind the curve. In addition, the Fed’s arbitrary 2% target has been proven to be too low as it precipitated the Great Financial Crisis.
The Fed should adopt a more flexible target range of 2-3% and modernize CPI/PCE to ensure real time pricing of inflation. It should also adopt an unemployment target range to balance out its stated dual mandate. It should adopt a more free market approach of targeting steady growth of the money supply in line with nominal GDP growth and letting the Fed Funds rate float within a larger band based on market conditions. Finally, the Fed needs to modify its inflation forecasting models to incorporate the money supply as the critical independent variable. The new Fed Chair should be nominated that is committed to modifying the current dangerous policy framework.
Inflation is always caused by excessive money supply growth as occurred during the Pandemic (22% inflation with 22% excess money supply growth) and never by tariffs and deportation. The money supply (M0) shrank 5% Y/Y indicating that prices will continue to decline.
| Commodities |
We now believe that the recent surge in oil prices will cause an uptick in inflation resulting in stagnation, so we are declaring victory on our StagDeflation call as all inflation readings this year have shown declining inflation with the critical shelter component recently continuing its slow deceleration dropping from .4 to .3 last month. The decline is likely to continue as the BLS only updates the index every six months and it is further lagged by the practice of surveying renewing leases. In fact, our PCE-R index, which utilizes market prices, is already at the Fed’s arbitrary 2% target and we project that even the reported PCE Core will decline to 2% by mid-next year as the higher shelter readings over the last year roll off.
The rapid rise in oil prices will impact both headline inflation and will bleed through to core as all companies use energy for both manufacturing and services. Oil prices are a critical predictor of inflation as the use of energy is ubiquitous unlike increases from tariffs which are by definition a one time increase that should be ignored for the purposes of setting monetary policy. We also continue to forecast the US economy will decelerate into the 1-2% growth range as ultra-tight Fed policy weighs on the housing and construction industries. We do not forecast a recession, which is the normal outcome of a Fed tightening cycle, as tech spending is booming which is offsetting the decline in the interest sensitive sectors. We forecast that this slowing will force the Fed to cut twice this year as the slowing economy impacts the labor market.
We lowered our 2025 target on oil from $80 to $70 (range of $60-80) as it has become clear that Trump will use his influence with the Saudis and Russia to limit price increases despite tighter sanction on Iran. This policy will offset a good portion of one-time price increases from tariffs. We do not expect an increase in US production. We do see support for oil below $60 as most forecasters ignore the price elasticity of supply and demand for oil. Middle East wars will only impact prices if oil production facilities are destroyed.
Pollution taxes are by far the most economic method to rapidly reduce carbon and improve the environment. Limiting natural gas production is highly destructive to the global environment and has led to regime change in Europe.
President Trump has indicated that he will pressure OPEC, particularly Saudi Arabia, to increase oil production and keep prices low. At the same time, Trump supports domestic drilling which is positive for U.S. production volumes. Therefore, companies with volume exposure have outperformed those with commodity price sensitivity. We have lowered our oil price target to $60 – 70 per barrel.
Artificial Intelligence and data centers have opened up new growth prospects for natural gas midstream companies to supply gas fired power plants. Natural gas plants have some of the shortest times to build and we believe they are best positioned to supply reliable power quickly.