June 2025 Commentary and Economic Outlook
- InfraCap Management
- 24 minutes ago
- 7 min read
JUNE 2025 EDITION:
Commentary and Economic Outlook
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 | Stock Market: |
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 $150 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 $1.9 trillion or 6.5% of GDP to $1.7 trillion or 5.5% in fiscal 2026.
The job market is starting to contract with the best leading indicator, continuing claims, rising to over 1.9MM which is the highest level since the Pandemic.
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 80% from 70% at the beginning of the President’s term and the probability of the Senate going to the Democrats rose from 20% to 30%. 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.
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We continue to believe that the Fed’s inflation forecasting models are completely broken which focus on the failed Phillips Curve theory and the discredited expectations theory of inflation, and, consequently, the 3% forecast for PCE Core this year is way too high. We forecast that there will be an uptick in inflation due to higher oil prices over the next couple of months. It is important to note that higher energy prices bleed through to core as all businesses. However, thereafter we expect inflation to continue to moderate as the shelter component starts to reflect market prices for rent. We expect oil prices to moderate after more clarity develops in the Middle East. We also believe the economy continues to decelerate as housing starts decline and commercial construction also decelerates. We still expect the Fed to cut rates two times this year as the employment market continues to weaken and the impact of tariffs on inflation continues to be muted.
The Fed’s statement and dot plot were in line with expectations with the Fed raising inflation expectations for 2025 from 2.8% to 3.0% and reduced the growth forecast to 1.3% from 1.7%. The SEP kept 2 rate cuts this year but reduced the 2026 expected cuts by one but kept the long term expected rate at 3%. Stocks and bonds were relatively stable ahead of the press conference.
Unemployment claims, a critical leading indicator of the job market, increased with weekly claims up to 248k vs. expectations of 242k and continuing claims rising to 1,956k vs. expectations of 1,910k. PPI also printed cool at .1% vs expectations of .3%. with core also coming in at .1% vs. expectations of .3. The combination of the CPI and PPI releases implies that PCE core will come in .17% for May. We forecast that PCE core will roll down to 2.1% by May of next year.
Both releases validate our StagDeflation call with the continuing claims data indicating a substantial slow down in the job market. The Fed should absolutely cut rates at its June meeting but will not as it has no ability to forecast inflation as it uses flawed inflation forecasting models that incorporate the discredited “expectations” theory of inflation and the failed Phillips Curve theory. The critical endogenous or independent variables that predict inflation are the money supply and energy prices. Both of these indicators are down for the year and the lagged shelter component of CPI finally is starting to reflect the collapse in market rent growth. Importantly, our real time PCE index that utilizes real time rents to estimate shelter is now at 2.0% Y/Y. We do expect the Fed to cut 3 times this year as the labor market continues to weaken in the second half of the year and inflation continues to decline.
We attribute the recent rise in the US 10-year from 4.16% on April 30 to as high as 4.6% was precipitated by 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.
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 3 times this year. The market had failed to recognize that tariffs are recessionary/deflationary as the tax revenue reduces the deficit.
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.
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.