Midyear macro outlook: Predictably unpredictable

BRIAN HESS: Today we'd like to start by looking ahead to the second half of this year. It's been a wild 2025 so far, to say the least, and not the easiest time to build high conviction views, but we do feel pretty confident about the slowing trend we've been seeing in the US economy. And so, Garrett, can you please describe our growth outlook for the rest of this year?

GARRETT MELSON: Yeah, thanks, Brian. I think first of all, there's been quite a bunch of events that have unfolded over the last couple of months here since our last call. And I think for all intents and purposes, it's largely been a round-trip both in policies as well as in markets. And you take a look at the S&P, we're just under 3% off the all-time highs. And with respect to tariff rates, we're largely back to where the consensus thought was prior to Liberation Day. So as much that's kind of happened in the last couple of months since we were last on this call, we're kind of back to where we started the year.

And that is to say, I think the setup now, is that markets are back to basically being somewhat overly sanguine on the growth outlook, and overly pessimistic somewhat on the inflation backdrop. And while recession's no longer the base case, that extreme left tail has certainly been chopped off, as we've seen the administration tone down the trade rhetoric. I think the risk now is that we might be kind of sowing the seeds for another growth scare.

And this time, it's not going to be one that's really driven by trade risks and uncertainties and elevated tariff rates, but one that's really fueled by that organic linear cooling that we've been talking about in the economy for some time. So I think that's really the big story. Going back to our call last quarter, we focused in on really the key drivers of the economy. And, when you walk through that list, a lot of that still remains the case. Housing's still in stasis, rates where they are right now, mortgages, rates simply just don't work for the housing market.

Now you have an added headwind of housing completed inventory on the rise, and that means that home builders are probably going to start dialing back in terms of new starts. And that weighs on construction activity. If you look over on the nonresidential side, CapEx outside the AI space has basically been going nowhere for the last couple of years. It's only been adding about 12 bips to growth over the last seven quarters. So that's not doing much, and lower oil prices just weigh on some of that CapEx spend in the oil patch even further.

So don't expect a whole lot out of nonresidential investment in CapEx. The fiscal impulse, we will touch on a little bit today, but the bigger story really hasn't been federal spending. It's been state and local governments that have basically been doing the lion's share of the contribution to growth. But that's rolling over, as those budgets contract here.

So ultimately, at the end of the day, it leaves you with the consumer as that lone source of a growth impulse. And at the end of the day, that comes down to labor market trajectories.

So I want to spend a couple minutes just walking through a couple key thoughts on the labor market here, because I think that's really what is going to be driving the overall outlook for the economy, as well as I think, some of the market narratives as we push on through the rest of the year. So starting with the first slide here, I think one way to contextualize the cooling in the labor market, is this idea of the Beveridge curve. That's just basically plotting the relationship between the job openings rate. So that's the data that we get from the JOLTS survey on your y-axis across the unemployment rate on your x-axis. Basic idea being here is, that as you see job openings rates falling, which suggests that labor demand is cooling, well, you tend to start to see upside pressure on the unemployment rate. This has actually been a key underpinning of our soft landing call over the last couple years. We argue that you could basically move down that vertical portion of the curve, and you can see that with all the red dots here. Basically, that's the data points going back to the beginning of 2023.

But where we are now, you're starting to get to a much flatter portion of that curve.

And what that suggests, is that as you start to see labor market demand ease further from here, you're risking seeing a much more mechanical and tight linkage to upside pressure on the unemployment rate here. And I think that's going to be the story here moving forward, and it has been for some time, which is that growth continues to cool. Now you have some added overhangs from tariff uncertainty. It's certainly off the boil, but it's still there. We still don't exactly how this is all going to play out. And it's not necessarily a recessionary headwind, but at the margin, that represents somewhat of a tax on consumption, suggests a softer growth backdrop, and that means that you probably see labor demand cooling a little bit further. And again, that suggests that you likely see the momentum for labor market and for the unemployment rate skewed to the upside here. Now, that being said, we'll never be ones to bet against the US consumer. If there's one thing that does best, it spends incomes. But when you actually break down income growth, I think there's a really interesting story here about what's playing out this year. And on the next slide, you can see what's going on. When you break down the personal income for consumers every single month, there's a lot of different components to that. And I think what really stands out over the last four months, is the key driver of those healthy income growth numbers that we've seen to start the year is really a function of transfer payments from the government. And those really boil down to basically one-offs every single month. Now, you can say, well, if they're one-offs for different reasons and we're still getting them, that's still helpful for consumption. And it is, but it is somewhat obscuring the underlying trends for organic wage and salary income growth. And that's what you can see here in the light blue lines. Just to call out some of the distortions here. January, you always see a little bit of a spike from some of these cost of living adjustments, namely tied to Social Security payments. So we got that in the January print. February, we saw some health insurance tax credits, some settlement payments from lawsuits. March was farm subsidies from the government in response to the trade war. And then April was retroactive Social Security payments as a result of the new law that went into effect this year. So all of that is to say, if you include those transfer payments, your income growth looks pretty solid. But when you really start to zero in on what drives incomes, what drives consumption, it's really kind of stagnating here. It's still OK, but nominal wage and salary disbursements are only growing about 2.6% annualized so far this year. So it certainly does suggest that as labor markets have cooled off, you're continuing to see income growth slowing with it. And I think that's really the big story here. On the next slide, you can see how income and consumption growth tend to oscillate around each other over time. You tend to see these periods, where consumers spend out of income, maybe consumption outpaces income for a couple of months or quarters. And then you start to see an oscillation and a reversion, where maybe savings rates start to tick up a little bit higher and consumption falls. But over time, they generally track each other. But we're coming out of this environment over the past year or so, where personal income has really not kept pace with consumption. It's only grown about 1.1% through the trailing year ending in March.

And when you look at consumption, it's been growing just over 3%. So what does that suggest? It suggests that consumers have really been driving down their savings rates. And that's not a sustainable source of fuel for consumption here. And it suggests that eventually, you have to see some of that reversion in terms of incremental savings rates, unless you see a pickup in wage growth, which we just simply aren't seeing with that cooling going on in the labor market here. And so when you really think about it, I think it's a hard case to make that you're going to continue to see that downside pressure on the savings rate. If anything, this is probably an environment where given the state of consumer confidence, and admittedly, that's not been a great read on actual consumer behaviors, but consumer confidence still is well off the highs. You continue to see consumer opinions of the labor market has certainly eased up. And you still have a lot of uncertainty on the policy front. So given that, it's hard to see why consumers would continue to compress that saving rate.

If anything, they might actually be driving that up a little higher, which suggests that as you move through the remainder of the year, you're probably going to start to see that light blue line of personal consumption start to converge back down towards income. So maybe that meets in the middle, but I think it means that you're going to see some downside for consumption as you move through the year. And at the end of the day, I think really the heart of the issue, is just simply that the labor markets are cooling. And that's a function of just policy being restrictive. And I think a pretty easy way to visualize that, is on this final slide here. You're just looking at wage and salary disbursements in purple. And we've overlaid that versus the Fed funds rate. And I've called out a couple areas here.

Obviously, they all are occurring right before recessions. But those are all the periods over the last 40, 45 years where wage growth has fallen below the Fed's policy rate. And it's pretty clear to see that great things don't generally happen when you're falling into that type of environment here. Now, that's not to say that our expectation is that we're sealing the deal for a recession, but I think it does suggest that policy is too tight right now. You can expand that out past the labor market to CapEx, to the housing market. There's a pretty easy solution to what's ailing the economy right now. But the issue is, as long as you have this uncertainty on the policy front with respect to trade, the longer that keeps the Fed sidelined. And that just means passive tightening of policy, which just continues to exacerbate that downside risk here. So it's not to say that I think a recession is set in stone, but I do think that between now and kind of a resurgence in growth, you're probably going to see some of the labor market data and some of that consumption data ease up before it gets better.

BRIAN HESS: Thank you, Garrett. So a lot hinges on the US consumer. This is a story we've been telling for a while. And unfortunately, the signs point to a continued slowdown there, which should hold back growth overall. Now, the other side of the growth coin is inflation. And that's been getting a lot of attention this year, thanks to the tariff uncertainty and the potential pass-through to inflation we could get from tariffs. But away from goods prices, which would be the sector of the economy most impacted by tariffs, we've been seeing a fairly consistent disinflationary trend. So, Jack, can you please walk us through some of the key components in our inflation outlook?

JACK JANASIEWSICZ: Yeah, and I think it's interesting, too, because one of the things that we get often asked by our clients really revolves around the idea of the potential for a stagflationary outcome. And I think, again, that stagflation backdrop does require a little bit of a definition. You need to define those parameters in terms of how much of a slowing are you expecting, and how much are you expecting inflation to pick back up in here. And I think at the margin, as Garrett just outlined, we're certainly expecting a little bit of a slowing on the growth front. And wouldn't be surprised, at least in the near term, to see a little bit of a pickup in inflation. But to a point where we start to get a little bit concerned that it ultimately ruins the economy, I think that might be getting a little bit ahead of ourselves.

So I think there's a couple things that are worth talking to here. In this first slide, we're just simply looking at market-based ideas or market-based pricing of what inflation potentially could look like here. And it's the inflation swap. So you can see here on the light blue line, that's the one-year inflation swap. And then the purple line below it is the one-year forward rate. So think of that as being 366 days from today, what will one year forward expectations look like for inflation. And you can see there's a divergence. You've got the one year number pricing in, an inflationary pickup, certainly reflective of the potential concerns around tariffs. But you go out past that one year hurdle and that inflation number starts to move back in the other direction. And so I think a couple of takeaways here. One, certainly, we do expect a little bit of a bump in the interim on the inflation backdrop. But as we start to see that impact the overall economy in the slowing of the labor market that Garrett just walked you through, probably start to see some demand destruction in there. And the slowing of the economy then filters its way back into lower demand, which puts some downward pressure on prices. And so certainly, a short term blip, but longer term, maybe not quite as the stagflationary concerns that maybe we're hearing about. But I think it's also interesting to talk to a few other things here, because there are some offsets, I think, to what is really behind the scenes with inflation. Maybe those inflation fears are a little bit overstated. And what you're simply looking at here, we're talking about the shelter component within that CPI and PCE basket. You're talking about rents, primary residence of rents, and owners' equivalent rent, and we're basically looking at a bunch of different metrics that are focused on real-time pricing. And you can see that light blue line. That's the line item that goes into the CPI basket. And you can see that we've pushed forward a lot of these real-time metrics by almost four quarters, because they tend to actually lead the market. And you've got more of a lag that comes through with regard to the inflation prints that you're picking up within the inflation basket. So what are we seeing? A continued downward move, basically, in all these individual line items. And a couple other things that I think are worth highlighting here, and these are some nuggets, I know Garrett touched a little bit about on some of this with the housing market, but if you listen to some of the commentary, for example, that just came out from Redfin, they're saying there's an estimated 1.9 million home sellers in the United States housing market right now, and an estimated 1.5 million home buyers. So, in other words, there's a gap there of almost a third, where you have more sellers than buyers. And so if you go back in history, and the data goes back to about 2013, we've really never seen this number in both the absolute number, as well as the percentage, where you have this number of sellers outpacing buyers.

And obviously, the ramifications if you think on that, are pretty clear. If there're simply more sellers in the market than sales, got to expect inventories will rise and prices will fall here. And yeah, I know we get quite a bit of pushback. People will argue with us, saying, well, we're not really seeing that in our market, so to speak. And I think some of this price weakness in the housing market is a little bit regional, a little bit idiosyncratic here. But where are we seeing those biggest declines occurring? Those are the states that had actually the strongest contribution to construction over the last couple years. So you're talking about Florida, California. Arizona, Texas. A lot of these are seeing on a month on month annualized basis, drops in prices of anywhere between 4% and 6%. But take that one step further, and I think the broader market risk here is the knock on effect. When you have prices declining in places where housing has been getting built, you probably expect that construction is likely to decline going forward in those areas. And the 10 states with the steepest price declines represent about half of the construction in the United States. So you certainly could expect to see the knock on with growth in jobs in those areas of the economy, in the markets. And a couple of more stats, I think to hammer home the same point here. Over the last 12 months, those finished unsold, new housing inventories have climbed roughly by about 30%. And when those finished unsold inventories are rising, single family homes starts tend to fall. And with sluggish demand and again, we talked about those rates being a little bit, I think, restrictive in terms of new purchases there, there's more reasons to sell homes, you probably won't be breaking ground on new homes. And that's just the one economic tailwind that's just not going to be there. So the bottom line here, the rise in housing inventory, it's weighing on home price growth. Look at the Zillow data. Home values have contracted both in March and April. And they're up less than 1.5% over the last 12 months. So I think you should expect to continue to see downward pressure on rent of primary residences and OER as a result. And why is that important? Well, those two components within the inflation basket, that's 42% of core CPI and 18% in core PCE. So you can see how that would have a very, very big downward pressure, downward pull on inflation going forward. And as Garrett also highlighted here, some of the concerns that we're seeing in the labor market, we've been talking about certainly a slowing there. But again, I think the key point to hammer home on this one, as nominal wages continue to slow and you get a little bit of that inflation impulse, so you a little bit of rising prices, that simply equates to less consumption. And that ultimately filters into lower growth. And even if we look at some of the more recent data that's come out, the ADP numbers, that implied that private payroll growth was coming in at basically flat. I mean, the last numbers that we had the other day showed a rise of just 37,000. That's well below the 60,000 increase that we had seen in April. Over the last three months, those ADP numbers have averaged roughly gains of around 81,000. That's the weakest level that we've seen in almost two years. If we look at the JOLTS data, so the Job Openings and Labor Turnover Survey that we get, openings did jump, but the three-month moving average of those openings, that's basically pushing to a fresh low. So looking into the composition of the data, also is quite telling there. You're looking at slowing in openings for the goods-producing industries, specifically manufacturing and construction. Those continue to slide. So when you put all these things together, you're certainly seeing increased signs of slack in the labor market. That probably will continue to put downward pressure on wage growth. That's what you're looking at in this chart right here. Three different metrics that we pay attention to measuring wage growth. All of them are heading in the same direction, and that's lower.

And again, when you think about the cyclical portions of the labor market, those have been cooling in the acyclical portions, such as health care and education have been the primary drivers. That composition of that wage growth in job ads really isn't what you want to see from a strong labor market perspective. The last thing to highlight on the inflation front, it's really on the energy price side. So here, you're looking at basically the average for unleaded gasoline across the United States. On top of that, you're looking at crude oil prices.

And you can see here, that you're looking at levels that really we haven't seen back to 2021. So if you just think about from an economic impact perspective, as you start to get lower energy prices, when you think about it from a manufacturing perspective, that does put a little bit of downward pressure on some of those input costs. So that certainly should help to absorb maybe a little bit of that potential pass-through from tariffs. So, all in all, when we start to think about the pull through that potentially could hit from higher prices, I think we're ignoring the fact that maybe there are some other areas within the inflation basket that are actually offering up potential offsets to that. And as a result, maybe that inflationary impulse that everybody's worried about from tariffs, might not be quite as dramatic, simply because you're seeing a lot of those other portions of the basket continuing to disinflate and deflate, offering up that potential offset here. And the last thing to bring this all together, we're just simply looking at the Atlanta Fed Sticky Price Index. So let's bring this all together. It's simply a measurement of price changes for particular components within the CPI basket. The way the Atlanta Fed actually defines this, it's basically things that don't really tend to move in prices over 4 and 1/2 months or so. And they call those sticky prices. So think of those goods, things like medical services, education, personal care, housing expenses. Those tend to really not move with the economy, so to speak. And so as a result, tending to focus a little bit on that. And those are the things that are a little bit harder to move lower. And if you look at this chart here, you're certainly seeing the trend, which is tending to move lower here. So I think there's plenty of evidence that maybe the concerns that we're seeing around inflation, there are some offsets here. And I think just the point we're trying to make, is simply, maybe there are some things that we should be paying attention to that might be actually offering up a little bit of an offset to potential tariff increases. And as a result, maybe the concerns that we're seeing right now over inflation at the margin may be a little bit overstated.

BRIAN HESS: Jack, I have a quick follow-on question for you. You just made a fairly strong case that inflation risks are not too severe, and we could even see some disinflation, particularly if the tariff levels stay close to this baseline 10% level. And Garrett made a fairly compelling case for why we should get a slowdown in the economy. Presumably, the Fed is seeing these things as well. They have hundreds of economists at their disposal.

So what do you think it would take for the Fed to be more comfortable with the idea of cutting interest rates? What are they looking for? What would they like to have in hand before they're willing to take that step?

JACK JANASIEWSICZ: Yeah, and I think this is part one of our calls here, is simply that the balance of risks right now seems to be somewhat balanced in terms of just the commentary we've seen from the Fed over the last couple of meetings. The worry over the dual mandate, both price stability and the full employment there. But I think we're going to start to see a little bit of a shift going forward, and that focus turns a little bit more on the labor side of the economy. Because I think, as Garrett sort outlined here, we're expecting a little bit of more softer data going forward. And if the inflation numbers continue to come in where they've been coming in, I think that shifts the balance of risks to the labor side.

And I wouldn't be shocked if we start to get maybe to the July meeting and the Fed starts to sound a little bit more dovish, teeing up the potential for rate cuts past that July meeting. So really, I think it really comes down to that labor market hinge, and that's the key. Garrett, obviously, highlighted that, as well, on his portion there.

BRIAN HESS: So tomorrow will be a big day then. We get the jobs numbers for May. And by the way, that Redfin article you referenced, I read that, as well. It came out about a week ago. I thought it was excellent. So anybody interested in finding that, I think if you search for Redfin more sellers than buyers, you'll probably get the link pretty easily. I recommend it. Quite a good look at the housing market right now. OK, now that we've covered growth and inflation in the US, let's broaden out to take a more global view. And I'd like to address the question of US exceptionalism. One of the byproducts of the Liberation Day announcement has definitely been a reassessment by many international investors regarding the desirability of keeping their money here in the US. So we've seen capital repatriated back to many places. This has put upward pressure on a lot of currencies. It certainly put downward pressure on the dollar across the board, but the euro has been a big beneficiary of it, with a strong rally. International stocks, have as well, particularly in Europe, have outperformed US indices. And meanwhile, gold has been marching relentlessly higher, which is a clear dollar alternative. So, Garrett, what's your take on the state of US exceptionalism? Are there remaining benefits of investing in the US for foreigners, and how about the attractiveness of the dollar at this stage?

GARRETT MELSON: Yeah, well, I mean, I think just walk through the whole list of why we've kind of hit this peak or bull market in calls for the end of US exceptionalism. And I think it's kind of just the flip side of the coin of where we were at the end of last year, which was just a full embracement by the consensus of this idea of secular US exceptionalism.

We were certainly part of that consensus. But now I think, we would differ a little bit from where that consensus is. I know a lot of the price action back in April, which has certainly cooled down, but that kind of EM type action, where equities, rates, and dollar were selling off in unison, it's typically only action that you see play out in emerging economies.

And so I think they got a lot of imaginations running wild. To be fair, that only happened for a couple trading days. But I do think that there were enough of these breadcrumbs to suggest maybe we're seeing some capital leakage, and maybe that shine has come off of the US in terms of its standing above the rest of the world. And I think it is fair to say that some of the shine has come off. But to call this end of US exceptionalism and translate that into a structural decline in relative performance for the dollar and US assets relative to the rest of the world, I think that's a bridge too far. So walking through the drivers of the US exceptionalism story, I think it's kind of easy to see where you can make some arguments that the shine has come off. But there's still a lot of areas where that exceptionalism and that relative strength to a lot of our peers on a global basis is still very, very much intact, even if that spread has converged at the margin here. At the end of the day, I think one of the big drivers here is, the US still has the broadest, the largest the deepest capital markets. And I that's really important to keep in mind from a capital flow perspective. Foreign markets and foreign savings are just simply too large for a lot of these smaller domestic markets. Now, yes, do have a lot of alternatives on a global basis, but at the end of the day, it's hard to find the type of depth and breadth as you do here in the US. And so as a result, you see a lot of capital is moving towards those assets here in the US. And I think that's still pretty intact.

Stronger economic growth, we can argue that maybe that spread and that premium has converged and compressed a little bit, but it's still intact. Currency has been volatile recently, but overall, currency has generally been significantly more stable than global alternatives. The list goes on and on. And I think that fourth bullet here, I think is the biggest one that a lot of the bandwagoners on the end of US exceptionalism has latched on to, which is that the policies being pursued and the methodologies being utilized by the administration has kind of shaken that idea of the rule of law, due process, the resilience of the political system. I think it's really important, anytime we're talking about investments, you have to put on your political blinders. Again, has maybe some of that been shaken? Sure. Maybe some global investors have taken that and extrapolated that. Fine. But at the end of the day, a lot of those processes, a lot of those checks and balances, we're starting to see some signs that they're still intact here. So I think a lot of these fears are a little bit overdone. And at the end of the day, as an equity investor, I think you have to really consider the bottom couple bullets here. When it comes to the corporate landscape here in the US, it's still head and shoulders above the rest of the world. You take a look at the US companies, they dominate in terms of global technology leadership. They exhibit much greater productivity, flexibility, especially when it comes to labor markets. And that just translates to overall greater dynamism. And at the end of the day, that means greater profitability here. So I think from a broad economic perspective, OK, sure, you can say that a lot of these have seen a little bit of that edge come off, but that edge is still intact. And certainly from an equity markets perspective, a lot of these companies still maintain that leadership above global peers. And so I think a lot of that story is a little bit overdone. Now, on the FX side, I think there's something really interesting here. And so this is, I think, one of the bigger stories is in terms of the end of US exceptionalism. As a global investor, it's kind of been a double whammy--

--where you have that FX kicker that's been really helpful for returns when you bring that back to your local currency, but it's been more painful recently as you had local currency underperformance, at least in the early part of the year for US assets relative to the rest of the world, and then on top of that, the dollar has underperformed and sold off. And so as an international investor, that's the double whammy. But I think the big fear, and what's gotten this narrative at the end of US exceptionalism going, is again, it seems a little bit different. And the dollar hasn't quite seemed to be behaving as I think our frameworks have gotten us accustomed to over the years. And I think one of the easiest frameworks, and to be fair, the drivers behind currency, there's quite a number. And I think more importantly, they tend to ebb and flow in importance over time. And so what might drive a currency in one period, may not be all that important in another. And I think that's part of what's been playing out over the last year, year and a half. But I do think that over the last decade or so, this idea of the dollar smile has been really helpful. And it's the sense that if you look at this chart, think of dollar performance in terms of that shape, that U shape, or that smile shape.

On either end, the dollar tends to benefit and strengthen relative to the rest of the world, because you either have this kind of safe haven bid to a risk off asset in a global recession or a slowing growth environment, or on the flip side, the US growth story is just continuing to move head and shoulders above the rest of the world. And you get these kind of procyclical flows into the US assets. Either one of those kind of underpins a bid to the dollar.

Where you really see weakness, is when the rest of the world outperforms the US economy. And I think this is the key. We're very much more used to seeing dollar weakness when the rest of the world catches up to the US. We are not very accustomed to seeing the rest of the world, or I should say this a different way, the US catching down to the rest of the world.

And I think that's exactly what we've seen play out this year. It's an environment where US growth has really been slashed because of some of the policies, and as a result, you're seeing that convergence down to the rest of the world. And that's actually what's leading to an adjustment in terms of the dollar here. So when you put it into that context, I think actually what the dollar is doing, makes a whole lot of sense. And it's not explained by rate differentials. It's not explained by some of these other drivers. It's just simply explained by the fact that that premium of US growth over the rest of the world has eroded. The US is getting downgraded closer to the rest of the world, and that means that the dollar is adjusting on the back of that. And I think if you look at the next slide here, it's a pretty easy exercise or case study in that. First off, one, if you look at the left-hand side of the chart, this is just simply looking at the euro dollar cross currency rate. And in the purple, you can see basically relative revisions for economic growth in the eurozone less the US. So when this line moves lower, that means that you have better revisions for the US relative to Europe and vice versa. And what do you see playing out here? Well, first off, in the first half of 2024, really the bulk of '24, it really wasn't about growth differentials driving currencies. It was more so about rate differentials. And that's what you can see, this relationship just simply wasn't as tight, and it wasn't really being driven by those relative revisions.

But as you got kind of at the bottom of that growth scare in September, you start to see the markets pivot to pricing in the Trump victory here, you started to see really the dollar tracking one for one with those growth revisions. And then that flipped basically at the beginning of this year. You kind of saw a stabilization in those relative revisions. And then it kind of played out in two phases. We had this catch-up of European growth expectations to the US, because of the German fiscal package announcement, that relaxation of that escape clause for deficit spending around defense spending in Europe. All that kind of helped lift expectations in Europe. And then the big move wider here, or to the upside in terms of those relative revisions in favor of the eurozone, was Liberation Day, which far more perniciously weighed on US growth expectations than the rest of the world.

And what'd you see happen? Basically, you saw this level shift higher in the euro. So I think the story here, is more so that you're basically having an adjustment to the new policies. But from here, it feels like the consensus is kind of extrapolating this into the future and calling for this structural weakness in the dollar. But if it's really just kind of rationalizing and adjusting to this new policy, where some of those growth differentials are a little bit tighter, maybe a lot of that move is played out here. Rate differentials actually suggest maybe the dollar should be strengthening here. And consensus might be getting a little bit offsides here. But I think the bottom line is, US exceptionalism still intact. Might be a little bit less bright. But I don't think the dollar is flashing any sort of warning sign of continued capital leakage, suggesting more weakness from here. If anything, you might actually be setting up for a little bit of a contrarian move, where the dollar stabilizes in here, or if anything, might actually strengthen into that consensus that's expecting just the opposite.

BRIAN HESS: Your comments on the euro and the dollar, Garrett, provide a nice segue into our next topic, where we do want to take a closer look at Europe. One of the bigger bets we have on in our tactical models right now, is an underweight position in developed international stocks. And those stocks have been benefiting from the currency translation effect, as the euro has moved higher. Now, Jack, you're a PM for these models and have spent a lot of time looking into Europe. As the optimism is picked up towards European financial assets, we've seen a lot of enthusiasm on the back of the defense spending and the infrastructure package. So what are your takeaways on the outlook for growth there for inflation in Europe and earnings momentum in the eurozone? And I would say, feel free to opine, as well, on some of the developments related to this greater government spending and the fiscal stimulus, since that does seem to be what really kickstarted the move higher in European assets before we got the Liberation Day, which added another leg to it. Jack, what you're seeing in Europe.

JACK JANASIEWSICZ: Yeah, I think I'm going to start right into this first chart, because I think it speaks volumes to what you were just sort of walking through there, Brian. All you're simply looking at here, I've rebased both the S&P 500 and the MSCI Europe Equity Index to the starting level of April 2. And think of April 2 as being Liberation Day.

So a lot of the narrative that we've been hearing about, has been this end of US exceptionalism, the end of globalization. And as a result, that's taking a little bit of the shine off of that US trade, if you will. And so a lot of these investors are taking their ball and going home, so to speak. But what's interesting, if you actually look at it from a local return perspective, so you can see here in the purple, that's the S&P, the gray line there is the European Equity Markets in euros. And so you can see basically since Liberation Day, the S&P 500 has actually outperformed the MSCI Europe index. The difference, however, is that orange line, that's where you start to then take into consideration the currency move. So, from a local market perspective, you really haven't seen that follow-through. It's really been all a function of the move in the currency market that's been driving that performance differential. And so for me, if I was really thinking about the end of US exceptionalism, and then all of this capital migrating away from US equities, I'd like to see a more persistent outperformance from those European equity markets. And we're just not seeing that.

So maybe it was a knee jerk reaction, a one-time trade, but the lack of follow-through I think is very interesting in here, and it's basically really been a function of the currency markets that Garrett really just walked us through. But if we start to think about the potential for the European market, you have to think about it in terms of what are the driving forces there.

And I think the big one that I'm pointing to here, is simply saying that Europe really can't rely on domestic consumption as a growth engine. I mean, you're just looking here at real final domestic demand in purple. It really hasn't gone anywhere since we basically bounced off of that rebound from COVID, and a stark difference between what you're seeing in the United States. And so again, the US economy is 70% is driven by consumption. It's a huge component for how the growth backdrop operates in the US. You don't see that in Europe. It's been largely flat. And so basically, Europe is forced to rely on importing growth from other countries. And that's going to be namely the US and from China. And if we think about what we just walked through with the short-term potential slowing of the US economy, that necessarily doesn't operate as a growth engine. And it also then looks to China. And I think there's a risk here of with this trade war continuing to persist, China might be looking for alternative markets to start dumping some of their exports. And you could see the European market suddenly starting to get flooded with a lot of these excess supply from China – which would A, certainly increase competition. But B, adding to that sort of inflationary impulse going forward there. So potentially some concerns with regard to the trade war adversely impacting the growth story there. And then take it one step further on that consumption backdrop. You're just simply looking here in the light blue lines, and this is the negotiated wage tracker that comes from the ECB. That's rolled over pretty hard. And you can see the service inflation numbers that tend to follow with it. So it's not surprising if wages are collapsing or markedly slowing. You probably would expect to see consumption slowing, as well. And that just continues to, I think, exacerbate that potential for that deflationary impulse here. So maybe at least at the margin, the ECB comes a little bit more supportive because that inflation backdrop certainly starts to work in its favor. But I think those growth engines really don't really come from anywhere other than at this point, government spending. And I think that's the key to think about here going forward.

But the trick with the government spending side though, much was made, as you were highlighting before, Brian, over the potential for Germany to get rid of the fiscal brake, and again, that basically allows them to spend a little bit more on defense spending. You're certainly expecting to see defense spending increase across the board for Europe as the Trump policy pullback from NATO. But a couple things to think about when you talk about defense spending. The first one there, from an economic perspective, we tend to think about things with money multipliers. And the incremental dollar that's spent, how many times does that work its way through the economy to give you incremental GDP growth.

And one of the lowest multipliers out there from a fiscal perspective, is military spending. And so, the multiplier there just really isn't that big. And to see that propagate growth throughout the rest of Europe, I think that's also challenging, as well. So as Germany's sort of drawing up some of that spending there in the broader backdrop, some of that money is actually going to find its way back to US contractors. So, I know a lot of people were very bulled up over the impact from increased government spending on the military side, maybe not quite the impulse that we thought. And I think the second issue, though, is that people are focusing on this infrastructure package that potentially has been announced from Germany. And certainly with a lot of the revisions of the rules there, it's giving them the leeway to actually increase spending, and even more importantly, increase debt issuance to fund that spending. You have to look at the EU rules, because the EU rules are the ones that are going to be coming into play here. Germany's already at a debt to GDP ratio of 60%.

That's the cap with regard to the European rule. So if they're going to be issuing more debt to fund this infrastructure program, they're going to be in violation of that rule.

So the question then becomes, will the broader European continent basically try to revive some of those fiscal rules? And quite frankly, they probably will. But that's going to take time. You have to get 18 members to get on board and vote for this. Then you have to dole out the contracts. So by the time a lot of this money actually gets put into place, and then you start to see it working its way into the real economy, you're probably talking years from now. So again, when you start to think about that impulse that we've seen coming from the government spending perspective, maybe we're getting a little bit ahead of ourselves with that knee jerk reaction. And again, thinking about those returns that I just showed since Liberation Day, you didn't see that consistent follow-through. And the other thing that I think we're paying attention to, is obviously, on the earnings front. And so this chart here, the blue line is simply looking at the relative performance between Europe and the US. So, any sort of upward sloping component of that blue line represents European equities outperforming US equities. And then the bar chart in the backdrop is simply looking at earnings revisions. And again, you're looking at Europe relative to the US. So when you get those bar charts pointing north, you have European revisions outpacing revisions in the United States. And I boxed in certain periods where you're seeing those earnings revisions in Europe exceeding those of the US. And not shockingly, those are the same periods where you start to see European equities outperform. Well, if you look at the most recent bout here, the last couple of weeks, you're actually seeing US earnings revisions outperforming. And not surprisingly, you're seeing that relative performance starting to roll over on that front.

So, I think there's a lot going on here with regard to the market's expectations. I think in general, though, as Garrett said, I think, yeah, maybe that gap is slowing and closing a little bit between the optimism. But to then fully subscribe to the idea that European or international equities will continue to outperform going forward, maybe we're getting a little bit ahead of ourselves with that one. So we're still a little bit suspect that this is the huge game-changing moment right now for international equities.

BRIAN HESS: That's great, Jack. Great summary. Bottom line, we're not chasing the move higher in European risk assets for the time being. Now we got a well-timed question in the chatbox about the big beautiful bill, and that's exactly where we were heading next.

So we have this bill working its way through Congress. It does have some spending and tax cuts in it. Garrett, how impactful might this bill be if it passes in its current form? And what's the outlook for US fiscal stimulus in general for the rest of the year, and into next year, I guess, as well?

GARRETT MELSON: Yeah, so it's one big beautiful bill, but I'd say, in short, it's not really all that big or beautiful when it comes to growth expectations and growth impulse here. In terms of some of the details behind that, first off, we talked about the state and local side of the fiscal impulse. And I wanted to share one slide with respect to that, just to put some numbers around that. This is an area that really has been the bigger driver of economic growth over the last couple years when it comes to government spending. Federal government spending has only added about 14 bips to quarterly growth for the last nine quarters. On the other hand, state, and local governments have driven about 44, 45 basis points every single quarter, so about three times the contribution to growth coming from state and local governments. And as you can see on this slide, that contribution is what shows up in purple here. And we've overlaid that with the Brookings Institution, which puts together this fiscal impulse measure or fiscal impact measure, which is basically trying to gauge, what's the impact or the contribution to GDP growth that's likely to come from state and local government spending and investment over the next couple years. And you're moving from a really sizable contributor down to something that's going to hover around 0, if anything, be a modest drag. So that's a big driver and supporter of growth that's basically going out the window over the next couple years here. So don't expect much out of state and local governments. So when we start to zoom in on the big beautiful bill, I think there's a couple things to keep in mind here. I've spent a lot of time digging through all the details in the Ways and Means Committees' measures and what made it through the House, and there's a couple things to keep in mind when you're talking about deficits and the impact of budgets here. The first thing is, I have two charts here, which is basically trying to show the same thing. It's showing that change in the deficit scaled as a percentage of GDP. But on the left- hand side, we're just looking at that exclusively from the concept of increase in the deficit.

On the right-hand side, we're trying to actually map that to, what's the impulse to growth. Because it's not just government spending. The level is not what actually adds to growth, it's the change in the level of spending that actually drives a growth impulse here. So it's that first derivative. And it's really important to consider the differences between budgetary scoring, which is what the CBO puts out when you hear about what the size of that deficit is going to be, versus what the actual contribution to growth is in terms of changes to what current law is. And that's, I think, really the key here. There's a couple nuances I want to get into to just put some numbers into the potential impact of the bill here. The first one, is that the primary driver of reduced revenue, so the primary expense in the bill, is just simply an extension of current law. That's the Tax Cuts and Jobs Act. And that's what you see on the left-hand chart here. The blue bars, that totals about a $4 trillion cost in terms of this bill here. And when you actually think about what's the incremental new tax cuts, that's basically no tax on tips, no tax on overtime, no tax on auto loans. There's a few other items mixed in there. It's pretty small, and it's very front end-loaded. And that's what you see here in the purple bars on the left-hand chart. So the biggest driver to that increase in the deficit comes next year. And it gets smaller and smaller. And then eventually, all those tax cuts actually sunset after 2028. And so what do you see actually playing out through the course of this budget over the next 10 years? Well, you get a little bit of a bounce and an increase in the deficit over the next four years or so, but it really peaks at around '27. And then those deficit increases actually start to tail off. And the other thing to think about is, how are they paying for these tax cuts to bring down that total bill? It's actually through a pretty meaningful cut to spending, namely in Medicaid and SNAP programs. Those are the food stamp programs. So when you put that all together here, two ways to think about this. One, at the headline, the CBO can include those tariff revenues, which is what you see here in the purple bars, the light purple. And so, it certainly looks like it's a big increase in the deficit. Now, we have no idea how long tariffs are going to remain in effect. We have no idea what rate they're going to be in for here. But if we just assume what we now for current levels of tariffs, that total is about $2.3 trillion in incremental revenue. So right off the bat, back that out from your total cost of this bill, and you can see the net effect is a much smaller increase to the deficit. Now that might sound great, but think about it from the impulse to growth perspective, which is really what the markets are going to care about. And that Tax Cuts and Jobs Act extension, that doesn't matter. That's basically just removing the risk of a fiscal cliff that everybody thought was always going to be averted anyway. And that really, at the end of the day, doesn't add to any sort of growth impulse. That's just keeping status quo for tax rates as they stand today. So what really matters from that fiscal impulse perspective, is those small purple bars. What's the new incremental tax cuts? And you just don't get a whole lot out of that. So now you're left with a short-lived and a somewhat small enhancement to the Tax Cuts package. And then you're offsetting that with really meaningful cuts to entitlements and some of these spending programs on the back end of that. So at the end of the day, you're only looking at a contribution to growth that peaks out in 2026 on the order of maybe 0.8%, 0.9%. Now you add in the effects of tariffs, you're getting about a 20 basis point boost of growth. And then you're actually back to a declining or an outright negative fiscal impulse. So bottom line is, you don't get a whole positive growth impulse out of this. And it's very short-lived, and it actually translates to a pretty meaningful growth drag, as you look into the out of years. Now, obviously, we'll get more budgets over the subsequent years. Who knows how that will change the policy moving forward? But the bottom line is, it's not really all that big and beautiful when it comes to a growth impulse. And the last thing to keep in mind is, this is a pretty regressive tax cut by nature. And you're pairing that with pretty regressive tariffs on top of that. And what do I mean by that? Well, your 20 basis point kicker to growth for 2026 might not pan out being all that much of a kicker to growth and consumption, because much of those tax cuts actually accrue to upper income earners.

And I have two forms to look at this. If you're cutting spending for Medicaid and SNAP programs, there's two options. Either states can refuse and just not offset that and fill in the gap, or on the right-hand side, states can say, hey, this is really going to hurt my voter base and our citizens, so we're going to step up and replace some of that with increased spending. Well, in the first case, it means a pretty big hit to disposable income after taxes for that lower income cohort. You see their disposable income fall by about 4%. Meanwhile, you can see the benefits to the tax cuts in light blue, almost a 4% increase to the upper income after tax incomes. Now, if we offset that, we can basically slash that drag for the lowest cohort by about half. So it's not quite as meaningful a drag. But the bottom line is, it's a regressive tax cut. It's a regressive tariff. And at the end of the day, that might actually limit that marginal impulse to consumption, because much of that accrues to upper income earners, which may spend some of that incremental income, but they're probably more prone to actually be saving and investing that. And as a result, you don't see as much bang for your buck in terms of that driver of a growth impulse. And at the end of the day, I should just mention, that's why we spend so much time redirecting the conversation away from tariffs, away from fiscal. That's why it really boils down to, what's the trajectory of the labor market. If you can get that right, you're probably going to see everything else fall into place on your broader economic call.

BRIAN HESS: Good point, Garrett. And I have to say, this webinar is turning into a little bit of a downer between the growth outlook, the skepticism on Europe, and now this regressive taxation. So for the last segment, we have maybe about seven or eight minutes left.

Let's see if we can find some opportunity or some silver lining out there. Jack, I'm going to turn to you. Let's just run through some markets, some opportunities maybe, growth versus value, large caps versus small caps, US versus international. What looks good? Where are you thinking about allocating that incremental dollar as we approach the second half?

JACK JANASIEWSICZ: Yeah, and maybe just to tie all of this together real quick, our base case is still not for a recession now, and even if you think about that potential downside risk where we do slip into one, we're still of the mind that the consumer is still in pretty good shape. The balance sheet at the corporate side and the household side, still in pretty good shape. So as a result, it's probably going to be a shallow recession. And you're probably going to actually start to see the Fed step in and help out. So again, let's not get too over our skis in terms of the narrative here, but we do expect a slowing. But if we do get the worst case scenario, we think it'll be pretty modest. But with that, I think when we start to look at the potential for opportunity here, one of the questions that we get quite a bit from clients, growth over value, is that still in play, should we be switching? And, our response there is simply, I think growth still is probably in the lead. And what you're simply looking at here, are the earnings growth by sector for the S&P 500. I've highlighted three of them in here, because that's where you see double digit growth for the next 12 months in terms of expectations. And then that last column, you're just looking at the change from the beginning of this year relative to where we are at the end of May. And you basically are getting those upward revisions there, as well. So if you think about the three sectors that tend to comprise growth, that's going to be information technology, communication services and to a lesser extent, consumer discretionaries. Two of those three sectors are highlighted on this chart here. So when you think about where the potential earnings growth is coming from, two of the three sectors that are still showing some pretty significant upside growth still reside in that growth bucket. So as a result, we still want to favor growth going forward in here. And it really comes down to the tech backdrop. A lot of people are making comments about the convergence between the Mag Seven and the overall market. That's what you're looking at here. So the Mag Seven in the light blue, you can see it continuing to converge back down to the broader markets.

And so as we get into towards the end of this year, you're not seeing that much of a premium for the Mag Seven. Although it's ironic, we've been doing this chart now for a couple of quarters, that convergence continues to get pushed out farther and farther. So it feels like maybe the market is underestimating the resiliency and earnings from the Mag Seven.

But I think the greater point here, just look at those orange bars. Those orange bars are remaining pretty consistent. And that's just tech. So again, going back to the growth value, tech, growth, and if you still want to have I think that barbell that we like, I'm still leaning into tech, I think that's also another way to think about the markets going forward here.

When we start to think about US versus Europe though, I think what's interesting is, just again, going back to those earnings expectations, and we're just not seeing quite the follow- through I think that we would hope to see if you wanted to get really bullish with that European trade. And you're just simply looking here at the next 12 months earnings estimates for the market, the S&P 500 versus the STOXX 600 rebased since the beginning of this year. And you can see here, the S&P 500 is basically back to the highs that we had seen right before we actually went into Liberation Day. Whereas Europe, you've seen a pretty marked shift here, where you're almost down almost 3% from the peak. So here we are, S&P 500 earnings revisions or those earnings estimates, back to the high that we've seen for the next 12 months. You're still well below those highs with regard to Europe in here.

So again, one of the reasons why we're still favoring more so that US trade relative to Europe. If we go through the headwinds, again, Garrett talked a little bit about the US exceptionalism checklist, so to speak, European headwinds here. I think if we pick and choose the big ones, for us, it really comes down to this idea of on the tech space again. And you just don't see that tech really manifesting itself in the European markets. And quite frankly, they're still well behind on a lot of fronts, whether it be digital services, the foundation, AI models, the Cloud Infrastructure. They just don't have that component. And that's where the bulk of the growth is still coming from. And when you start to talk about the S&P 500, almost a third of that is still there. The last one to point to, and again, this kind of goes back to the dollar smile, that story that Garrett was outlining. It's really not necessarily that Europe and the broader markets are catching up to the US. It's just the opposite. It's really more so that the US is catching down. And one way to also frame that same conversation, these are GDP estimates that we pulled off of Bloomberg. And I've shown them over the last couple of years in forecasting out to 2027. And you can see here, '23, this is the difference between the GDP expectations for US relative to Europe. So the difference between the two. So again, can see in 2023, US growth expectations far exceeding what the expectations were for Europe. Same thing for 2024, early part of 2025. And then you see that catch down trade, if you will. But what's interesting, you look at '26 and '27, you're kind of flatlining here. So you have that repricing, and now things are leveling off from that perspective. So when we start to think about that US trade relative to the rest of the world, it really comes down to that growth differential. And it sort of seems like the market has already repriced. And when you look at those forward indicators for expectations on growth, we've leveled off. US still growing at a far faster pace, but that rate of change leveling off, and it's a little bit more compatible here. So I'd like to see that divergence continue if I really wanted to get bullish on the international markets, and we're simply just not there yet.