Written by Steve Andrews
The US stock markets creep ever higher as we start the second half of the year. Although it looks like September might be the earliest that the Fed might cut the Funds rate, the markets appear to be tiring of the “when and if” regarding more rate cuts altogether.
High Rates Not Slowing Consumer or Business Activity
Few disagree that short-term US rates are too high, but most will agree that rates at current levels are doing little to impede consumer spending, investment, and economic growth. There is consensus that the Fed, while proceeding cautiously, will quickly step in and step-up rate cuts if the economy were to falter.
Volatility Declines as Earnings Expectations Fall
As concerns fade, stock investors and market volatility are displaying unusual calm of late - preferring instead to look ahead. As 2025 began, Q2 earnings were expected to rise 8.5% from Q2 2024 but those expectations were cut by more than half shortly after the start of this year.
Tariffs Remain a Wildcard, but Consumers Steady the Ship
While the markets have become less sensitive to tariff talk, tariff negotiations are ongoing, and sentiment could change quickly. In the meantime, the US consumer remains the backbone of the economy. They have done their part through thick and thin to shore up economic growth with their spending despite a relatively gloomy outlook. However, recent polls show that consumer pessimism appears to have bottomed out. Daily online polls from sites like YouGov and Civiqs show that more Americans say that their family’s financial situation has improved (the highest number since 2021), while those that say things are getting worse has slipped to the lowest level since January 2022. Their outlook for the economy has risen to levels last seen in October 2020. That’s not to say that consumers are euphoric, as the majority still say that the economy is getting worse instead of better, but the percent of those saying that things are getting better rose to the highest level since June 2020.
Major Tax Cuts Become Law Amid Fiscal Warnings
The Big Beautiful Bill was signed into law on July 4, making permanent the 2017 tax cuts and reducing or eliminating taxes on Social Security, tips, and overtime pay. The fight to secure passage was fierce, with the bill narrowly making it through the House (twice) and the Senate. Opponents to the bill pointed to America's surging debt - now above $36 trillion, or 124% of our annual GDP. The interest payments alone on the debt ($882 billion) account for 13% of the federal budget and there’s little wiggle room to cut expenses.
Sluggish Growth Tied to Transfers, Taxes, and Regulation
If you can’t lower the river (spending), you raise the bridge (increase income). Tax cuts boost economic growth and growing the economy is one sure way to increase tax income. US economic growth has slowed nearly 30% over the past 20 years from increasing government transfer payments, higher taxes, and regulatory burdens. From the 1960s into the early 2000s, US GDP grew at an average annual rate of 3.1%. However, following the 2008 financial crisis, and the government programs set up to support the economy (TARP, QE, etc.), and then the COVID shutdowns, massive federal government spending diverted fuel away from the economic growth engine. This slowed the average annual GDP growth to just 2.2% since 2008. That drop in GDP growth has lowered national income by over $1.7 trillion per year. If we could return GDP growth back to its long-term trend, the economy would be over 25% larger than it is today.
Productivity Gains Key to Reigniting Growth
Innovation, fed by technology and other sources, is important because GDP is essentially the sum of growth in the labor force plus growth in productivity. Both have averaged just over 1% for the past decade or so, which adds up to the average 2.2% GDP growth during that period. Since few expect labor force growth to accelerate much in the years ahead, due to retiring baby boomers and immigration crackdowns, we need to see an increase in productivity to boost GDP growth. The boom in AI, biotech, robotics and nanotechnologies will go a long way to boost US productivity and, as the tax picture has become clearer, businesses can plan for new investment with more confidence about the ground rules for depreciation and other considerations.
Labor Market Stays Solid with Rising Wages
The US economy has proved itself to be quite resilient, adding 1.8 million jobs over the past 12 months through June, with the Unemployment Rate easing to 4.1%, and private sector wages up 4.4% (year-over-year), according to payroll service firm ADP. Job openings rose to 7.8 million in May (the most recent data available). The “Misery Index” (the sum of the CPI and the unemployment rate) is 6.8%, compared with its long-term average of 9.0%, and Household Net Worth continues to reach new heights.
Private Sector Growth to Drive Second Half of 2025
A year ago, we were waiting for the first Fed rate cut, as disinflation had taken hold, giving the Fed the latitude to ease monetary policy. At that time, quarterly GDP was growing around 3.0% and the next recession was somewhere off in the future – at least 12 months away - as the stock market rally expanded from just the Magnificent 7, to the Russell 2000. Twelve months later, the next recession remains at least 6 – 12 months away. Now, the US consumer is going to get more help in supporting economic growth in the second half as our economic growth engine is in the process of “privatizing” - getting more of its strength from the private sector, and less from federal “stimulus.” An end to the tariff wars would be icing on the cake – adding to economic momentum - but that might take a while longer.
