Inflation Won’t Lead to Rate Cuts but a Weakening Economy Just Might

Investors are staring to focus more on growth than inflation as they search for keys to the next Fed rate move. (AFP via Getty Images)

President Donald Trump may ultimately get his wish for lower interest rates, but it isn’t likely to be the result of his intensifying criticism of Federal Reserve Chairman Jerome Powell.

Traders are paring bets on near-term rate cuts, and Treasury bond yields are edging higher, amid stubborn underlying inflation pressures tied to the president’s myriad tariffs. Trump himself said through his social media account that borrowing costs should be “3 points” lower. “One Trillion Dollars a year would be saved,” he declared.

But the broader theme expected to induce the Fed to lower rates is likely to come from a weakening consumer, and the broader demand destruction that tariff price hikes may ultimately trigger, than the still-muted inflation pressures.

“Investors are weighing the paradoxical potential for a ‘tariff recession’ to catalyze Fed rate cuts—an echo of what we saw in 2020,” David Miller, co-founder and chief investment officer at Catalyst Funds, wrote in a note to clients.

“In fact, markets now price in two 25-basis-point cuts by year-end, even as inflationary impulses remain stickier than expected due to supply chain shocks and deficit spending,” he added.

Thursday’s slate of economic and corporate headlines, in fact, is replete with early reads on consumer health, including the Commerce Department’s estimate of June retail sales and the Labor Department’s update on weekly jobless claims.

Americans spent around $720.1 billion last month, the Commerce Department said, a better than expected tally that was 0.6% from May levels. For the year, however, the overall average monthly gain is only 0.03%.

And a more granular look at consumer-spending momentum, the key drive of U.S. growth prospects, suggests some nascent weakness.

Delta Air Lines is seeing softness in demand from lower-income and price-conscious travelers, the carrier said last week.

United Airlines Holdings , which reported second-quarter earnings last night, also reported lower returns for each passenger, with the U.S. market leading the decline.

PepsiCo posted stronger-than-expected second-quarter earnings on Thursday, but that was largely powered by international market gains and a weaker U.S. dollar. Organic revenue in the drink and snack maker’s domestic market fell 2% from last year.

Still, Bank of America CEO Brian Moynihan told investors earlier this week that consumer spending remained “resilient” over the three months ending in June, and added that “our clients continue to see clarity with the changes in trade and tariffs” that will support activity into the back half of the year.

That might seem optimistic, given the uncertainty heading into President Trump’s Aug. 1 deadline for renewed levies on major trading partners, as well as his threat to impose tariffs on semiconductors, pharmaceuticals, and copper.

The bank’s “U.S. Consumer Meter,” meanwhile, a matrix of conditions linked to housing, inflation, spending, earnings, and employment, meanwhile, was last pegged at the lowest level in a year over the second quarter.

The Fed’s Beige Book, a reading of economic activity around the central bank’s 12 different regions published late Wednesday, showed a broad softening of consumer spending from late May into early July.

The Atlanta Fed’s GDPNow forecaster, a real-time reading of U.S. economic growth, continues to suggest a solid 2.6% advance over the second quarter, but key readings on PCE inflation, housing data, and employment have yet to factor in.

The consumer readings will be even more important for investors looking to gauge the impact of tariffs on the world’s biggest economy given that stock and bond markets have become somewhat numb to the risks tied to the president’s frequently changing statements.

The Cboe Volatility Index , or VIX, the market’s benchmark volatility gauge, remains pinned to the lowest levels of the year despite the tariff-headlines turmoil.

And even reports of a plan by the president to remove Powell from office before the end of his term next spring roiled stocks and the dollar only briefly on Wednesday.

“It’s a clear symptom of the resistance developed by markets for the roller coaster of headlines that have characterized Trump’s term so far,” ING’s foreign exchange strategist Francesco Pesole wrote in a note.

Investors are still in wait-and-see mode, however, with the August tariff deadline looming and lack of clarity on tariffs, inflation, and growth prospects.

The S&P 500 has traded within a tight 20-point closing-bell range for the past week, and has only risen 0.9% since the end of June.

Treasury bond yields are creeping higher, with benchmark 30-year paper topping the 5% mark earlier this week, the highest since late May.

Megacap tech earnings—including Google parent Alphabet on July 23 and Instagram parent Meta Platforms on July 30—will dominate headlines in the short term, but investors will need to closely track consumer-spending prospects, and their impact on GDP growth estimates, to get a true reading on market direction.

Write to Martin Baccardax at martin.baccardax@barrons.com