The whole world watched the meeting between Donald Trump and Vladimir Putin. At first glance, nothing fundamental was resolved, and real answers may only come later at a broader summit where all the key players will sit at the table. But geopolitical theater is, at this moment, secondary. What we are focused on is the state of the U.S. economy and the behavior of the markets – and that is where a much more important story is unfolding.
Markets have already fully priced in a rate cut in September. The level of ignorance could hardly be greater. Consumer inflation at first glance appeared flat or even declining, but when we break it down into individual components, we see the opposite. Core prices are rising. And even more alarming is producer inflation, which just recorded the largest increase since 2022. Yet markets completely overlook this.
In such an environment, there can be no talk of cutting rates. Powell will hold a special conference next week, and in our view, this scenario will be taken off the table. The only reason the Fed might even consider a cut is the fact that the U.S. economy is already simmering on the edge of recession, perhaps already in it. The U.S. also urgently needs to refinance its massive debt – and on the best possible terms. But how can you justify cutting rates when markets are at all-time highs? That would be science fiction. If the Fed does cut, it will be an open admission that the economy is seriously broken. Only then could markets find some rational footing and return to reality.
The July inflation data from the U.S. shows that price pressures persist.
Consumer Price Index (CPI, YoY):
Utility gas service: +13.8%
Electricity: +5.5%
Used cars: +4.8%
Medical care: +4.3%
Food away from home: +3.9%
Shelter: +3.7%
Transportation: +3.5%
Headline CPI: +2.7%
Declines were mostly seen in energy prices:
Fuel oil: -2.9%
Gasoline: -9.5%
At first glance, headline CPI doesn’t look dramatic, but the core components clearly show that inflationary pressure in the economy remains.
Producer Price Index (PPI, July):
Headline PPI: +0.9% MoM, +3.3% YoY
Core PPI (ex-food and energy): +0.9% MoM, +3.7% YoY
Services (final demand): +1.1% MoM
Goods (final demand): +0.7% MoM
Vegetables: +38.9% MoM
PPI shows the strongest rise since 2022 and is a clear signal that production costs will gradually spill over into consumer prices. This means the Fed has even less room for rate cuts than it might appear at first glance.
The stagflation scenario we wrote about half a year ago is back in play. If tariffs are truly passing higher costs into inflation – which the producer price data confirms – it’s only a matter of time before this feeds into consumer prices. Add to that a cooling labor market. If the downward trend continues, it will be a clear sign of stagnation or outright recession. The Fed will be trapped and won’t be able to cut rates until something truly breaks.
And this is precisely the point made recently by Stanley Druckenmiller, one of the world’s most successful investors:
“I’m worried the Fed declared victory over inflation too early. History shows that if you start easing too soon, inflation can come back – just like in the 1970s.”
His words perfectly capture the risk we see today.
So far, the market is ignoring all of this. Many investors compare today’s situation to the COVID era and the subsequent rally. But that’s an illusion. Today the economy and markets are in a completely different condition, and the Fed no longer has as many weapons at its disposal as it did after COVID.
As for us, of course we would also like to ride this trend with blinders on. During COVID we had no problem doing so. Back then it was obvious that the Fed was injecting enormous liquidity into the system and markets had to rise. But today we cannot ignore what most others choose to disregard, whether driven by greed or naive optimism. We will only participate once we are confident that markets are behaving in line with reality. We know that sooner or later this always happens, and we are convinced that we will once again deliver above-standard results to our clients.
The past few months have been moments that tested our patience. And as the saying goes, patience brings roses.
Note: This article is intended for informational purposes only and does not constitute investment advice. Investing in financial markets carries risks, and it is important to conduct your own analysis before making investment decisions.