Fed Eyes Rate Cuts While Trade Distorts Growth

Jeffrey Roach (00:03):

Hi, I am Jeffrey Roach, Chief Economist for LPL Financial with a few key charts to explain what we know about the current macro landscape. And the first one is this. Look past the headlines. Yes, that's right. When you look at the latest economic growth figures for Q1 and Q2, you have to look past the headlines. So in March, businesses pulled forward their imports to front run potential tariffs. And so in the second quarter, these businesses imported about 400 billion less. Hence, you see the unusual spikes in trade. The more important items to monitor is the split between consumer spending on goods and consumer spending on services. I highlighted in red boxes the contributions to growth from consumer spending in Q2 of this year relative to Q2 of last year. And this illustrates what we mean when we talk about a slowdown, especially in consumer's appetite for services like recreation, transportation, and hotel and restaurant spending.

Jeffrey Roach (01:01):

Investors should focus on this deceleration. Now that delinquencies are starting to rise for the upper income consumer, we expect consumer spending to moderate further in the coming quarters. The Fed will likely be in a good place to start cutting rates again later this year. Second, upside risks to near term inflation. Although we expect inflation to stabilize near the end of the year and into 2026, we expect inflation to post hotter than acceptable numbers, just like we saw as of this morning. I'm recording here on Thursday, July 31, and we received an update to the Fed's preferred inflation metric from the personal income and spending report. And as expected, annual inflation rose to 2.6% in June, and that's a bit higher if you subtract out food and energy prices, the so-called core inflation rate is 2.8%. Investors will have to be patient, but inflation will head back down by Q4.

Jeffrey Roach (01:56):

Third, the Fed is in a tight spot, inflation has ticked up. Growth seems stable, so why should the Fed cut rates? Well, that's because the gap between the Fed's upper bound and the current run rate of inflation is just too wide. The markets have had a tough time setting expectations on fed policy given the uncertainty. So this chart shows how volatile those rate cut expectations are. Just three months ago, investors expected four quarter point cuts, and now just maybe two cuts. I think it's a close call, but if we see consumer spending trends softer like we've seen and the inflation trajectory improve later this year, we could see some action taken at the remaining three meetings. So wherever you land on rate expectations on Wall Street, the more practical implications include the real likelihood that retail rates, that's the rates that hit the individuals on Main Street, will be lower by the end of the year. I hope this is good news for all of us as we position for 2026. Well, that's all for now, and if you want more insights on global market trends, follow us on social media and take care.