Same old song and dance: Slower growth, inflation and tariffs

JACK JANASIEWICZ: Hi. My name is Jack Janasiewicz. I'm lead portfolio strategist and a portfolio manager on the Models Program here for Natixis Investment Solutions.

BRIAN HESS: And I'm Brian Hess, investment strategist. This is Tactical Take. All right, Jack, well, we were joking last week that not a lot seems to have happened since the last time we recorded. It's been two or three weeks. There's been a lot of noise, but not so much signal.

But one thing that we can probably start with is the big recovery in equities around the world. The S&P 500 tested 6,000 again after a big correction. We're into a zone of resistance. But are you surprised by the resiliency we've seen in stocks?

JACK JANASIEWICZ: I think it makes sense. And I know in previous podcasts, we've talked about that left tail risk. And I think that's what I think the basis for the explanation really comes back to. When we got back down to 5,000 on the S&P 500, that was probably the worst-case scenario for tariffs. And, it's certainly obvious that worst-case scenario is off the table.

And so it's not surprising that we've seen a bounce in here. I think maybe the earnings backdrop has actually been maybe a little bit more resilient than people have expected. And that's probably helped to carry the equity market back up to the 6,000 level here. So combination of not as bad as people were expecting and earnings have actually been decent and starting to inflect higher, at least for estimates for the next 12 months. Put those two together, no, not surprising.

BRIAN HESS: And there really wasn't a big downshift in earnings estimates through the tariff turmoil. They were kind of steady.

JACK JANASIEWICZ: Yeah, they've held up better, a little bit worse for Europe. But in general, US, I think, maybe slumped maybe 2% at most. And we've since moved back up and recouped that.

BRIAN HESS: Interesting. And you mentioned Europe. There's been a big recovery there. And in fact, the DAX, I think, hit new highs for the year. What's driving that? Are you surprised by the outperformance of Europe? I mean, we had, earlier in the year, the big rally on the back of the announcement about more defense spending and the infrastructure plan. And European stocks zoomed.

Then we had liberation day, and they crashed down and caught down to the US. Now we're back to those pre-liberation day levels, and there's a lot of momentum, it seems like, for assets moving into European equities. Do you think this is a more durable trend, or is this something where you're thinking it's in the ninth inning?

JACK JANASIEWICZ: We're thinking more of it as that was a short-term trade. And if anything, maybe the relative outperformance that we've seen over the last few years of US equities can persist, but not at the magnitude. And I think part of that is because, to what you've just talked about, a little bit more increased fiscal spending.

So whether it be on infrastructure or defense, that will certainly help, at least from the growth rate perspective. We're certainly seeing from some of the wage data that we've just seen from the ECB that that's really starting to soften up. So from that perspective, maybe you actually get a little bit softer on the inflation front, on top of the idea that maybe China is going to be dumping some of its exports, that excess capacity that they have, because of what we're putting up on tariffs.

You get a little bit more disinflation working its way into the European market. And that gives a little bit more, I think, of cover for the ECB to maybe be a tad more easier than what the Fed is. So put those things together, again, not surprising you're getting decent equity performance out of the European backdrop and probably portfolio allocations as well.

We've heard about the shine coming off that US exceptionalism trade. So you get a little bit of money finding its way out of US markets back into international. So all this, not surprising either.

BRIAN HESS: Europe's, I guess, a good place to hide. You mentioned the disinflation potentially from China. There's also been currency strength, which helps with the imported price pressures. So that gives the ECB, like you're saying, cover to-- I don't know that they're going to cut rates much more from here, because they already have a fairly low policy rate. But they're not under the same pressure that some other central banks, like we're seeing in the UK, for example, or even the Fed here, which is very uncertain about their outlook.

JACK JANASIEWICZ: Yep.

BRIAN HESS: From a leadership standpoint, the rally off the lows in stocks seems to have favored large caps, seems to have favored growth. I guess that makes sense to us, given where we think we are in the cycle. So our cyclical view here would be that we are late cycle, right? And we're not necessarily predicting a downturn, but there's a tangible risk that could happen.

Later into the cycle, you start to see more defensive areas, like large cap growth, outperform. Where do you think it makes sense to be positioning for the time being?

JACK JANASIEWICZ: Yeah, I think we still favor the growth backdrop. And from a model perspective, we actually tilt it a little bit more towards growth with that most recent batch of trades we just put on. If you look at the next 12-month earnings estimates, you really have three sectors that are doing very well. You've got financials, which, obviously, are going to fall into the more of the value trade, if you will, but to a lesser extent discretionaries.

But the big one, comm services and tech-- and those are where you're still seeing, A, revisions higher and B, close to double digits, if not solid double-digit earnings expectations growth, going forward. And so again, those are the two biggest components that are going to make up that growth backdrop, if you will.

So it's not surprising. Where are you seeing the earnings upgrades? Where are you seeing the best estimates going forward? It really comes down to tech. And that's going to be a big chunk of the growth trade. So not surprising, growth continues to outperform.

BRIAN HESS: So there might be a cyclical argument you could make as to why growth makes sense. But it's also a bottom-up story, where that's where the earnings are coming from—

JACK JANASIEWICZ: Exactly.

BRIAN HESS: --so the market is rewarding that.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: Now, stocks have had a good move off the lows and recovered a lot of their lost ground. But the bond market has enjoyed a less friendly environment. We had a downgrade by Moody's of the US credit rating. That was kind of big news from a couple of Fridays ago, two or three Fridays ago.

And it's not just been a US story, but we've seen weakness in bond markets at the long end of the yield curves all over the world. Japanese Government Bonds, JGBs, 30 years traded above 3% briefly two weeks ago, which is a level that, jeez, I wasn't sure I'd see in my career. So that's been interesting. What do you make of the weakness at the very long end of these yield curves?

JACK JANASIEWICZ: Yeah, and I think the thing to highlight is what you just said. It's not just a US phenomenon. And a lot of people will point to the potential for a wider deficit here in the United States. Who's going to buy the debt? That whole story about why rates should be pushing higher in here.

And I'd push back a little bit on that. Certainly, we are certainly going to be seeing a wider deficit. And I'm sure that's a concern going forward. But if you go back to what Trump has been talking about, really since the campaign trail, we've known that he's going to spend money. We're going to have a wider fiscal deficit. The market's not getting blindsided by anything here. So I think it's a little bit surprising maybe that treasuries are not wider. You could maybe make the argument that 10 could easily be over 5. And they're not. So I just push back a little bit on some of that.

But to your point, I think it's a global phenomenon. And what is, I think, at the heart of that is maybe in general, I think there's a push for greater fiscal spending across the globe. And from that perspective, we're going to have to finance that. So the combination of greater spending, maybe a little bit of a growth impulse, which maybe feeds into an inflationary impulse to increase supply across the board, that all portends itself into the backup in the long end of the curve.

What's interesting, when I think about the 30-year JGB trade, I think a lot of that potentially is growth has been a little bit better. But more importantly, inflation seems to be stickier. And there was talk of them getting rid of the consumption tax.

And so if you think about that inflation being sticky, if you're getting rid of the consumption tax, that's more money in consumers' pockets, more consumption. So maybe those inflation numbers remain stickier for longer. The JGBs really are owned by the BOJ. So you have a really illiquid market. You put all these things together, and maybe it's not surprising you get that outside move on 30 year as a result of that.

BRIAN HESS: An interesting thing about JGBs and 30 years is that if you're a US-based investor, and you buy that bond, you can hedge it back to dollars. And you pick up 4% on that hedge if you use a one-month or a three-month forward. That gives you a 7% effective yield on a 30-year JGB.

I'm kind of surprised we haven't seen more US investors step in. And maybe it just speaks to the fact that in many ways, the BOJ has broken that market by buying so much of the bonds, that there's just not a lot of players who even look there anymore.

JACK JANASIEWICZ: I think that's spot on. Yeah, I think the JGB market has been sort of transformed because of the BOJ just taking it over, and that has changed that backdrop significantly.

BRIAN HESS: But I do think as those yields rise in Japan-- and we know that Japan is a big pool of capital. This is a savings-rich economy. It raises the bar for yields elsewhere in the world. So if you can get 3% in Japan, that Japanese investor is not looking at treasuries at the same lower levels. They're not looking at UK gilts at the levels they would have before.

So that probably is partly what's driving the correlation. But I think it's like you also said, a lot of little things, whether it's still concern about inflation from the tariffs. We have already large fiscal deficits in a lot of countries. Now we're thinking about more deficit spending. And there's a little bit of a growth impulse maybe from China, where there's more support.

So everything is kind of pointing in the same direction, while a lot of the major central banks are unable to cut rates due to the uncertainty. And that's just lifting yields and creating an interesting environment, where you've got stocks doing one thing and bonds doing the other.

While we've seen rates back up, some of the inflation news has actually been better, which also doesn't really line up very well. What has some of the inflation data in the US been like recently?

JACK JANASIEWICZ: Yeah. And so the perception has been a concern over, obviously, the tariff impact. And so if you look at the one-year inflation swaps market, because it's a financial instrument, we can trade. So you can readily observe that in the marketplace. That's been ticking higher.

But if you look at that one-year rate one year from today, so the one-year, one-year forward inflation swap, that's actually coming down. So you have the alligator jaws opening and then closing, so to speak. So if I read through to that, you've got the potential near-term impulse from tariffs being pushed through. And you see that pick it up in higher price levels.

But then maybe you start to see the substitution effect and more importantly, a slowing economy and some demand destruction in there. And that's where you start to see that one-year, one-year forward rate rolling over and converging back up, so to speak-- or down, in this case, I guess. So that's, I think, how the market's perceiving at least the near-term structure.

But there's a few things that I think are interesting that are worth thinking about, at least how we're thinking of things on the inflation front. One, oil prices and gasoline prices certainly are coming off the boil. So they're heading down towards $60 a barrel for oil; gasoline prices, $3 a gallon, or give or take.

BRIAN HESS: Yeah, energy-driven inflation is not a thing right now.

JACK JANASIEWICZ: Exactly. So from a headline perspective, you're seeing that disinflate Maybe there is a little bit of a pass-through from an inputs perspective. So when you think about the good side of the equation, a little bit of an offset maybe to tariffs, because you've got lower input costs from lower energy prices. So maybe that helps.

But the other bigger one is housing prices. And housing continues to show-- in that shelter component, they continue to show real-time prices softening. And that's a big line item within those inflation baskets, within core PC or almost at 40% or core CPI, I should say, at 40% core PCE, just 17% or 18% That's one line item.

BRIAN HESS: Yeah that's a big needle moving.

JACK JANASIEWICZ: So when you're talking about shelter prices rolling over, that's a pretty significant offset, I think, when you start to think about the holistic, OK, tariff worries. But you've got, also, other individual line items that can offset that.

So something to think about, going forward with regard to that sticky inflation backdrop because of tariffs, shelter is starting to continue to push lower in here. And I think that's a big thing that maybe should get a little bit more focal point from the market, so to speak.

BRIAN HESS: And wages remain soft, which should limit—

JACK JANASIEWICZ: Good point, yeah, exactly.

BRIAN HESS: Services inflation. So we've got shelter. We've got services inflation. We were looking at 145% tariffs on Chinese goods. Now we're looking at something like 30%, which is much less worrisome from an inflation backdrop. So all things from a month ago are moving in a more disinflationary trend.

JACK JANASIEWICZ: And I think that's important. Because if you think about what the Fed was just talking about from their balance of risks at the last meeting, they were pretty much split between the labor side, the labor mandate, the full employment mandate, and the price stability mandate. And I think maybe if we start to think about it in what we just outlined here, the shift might be away from the price stability side and more focused on the labor side.

So as a result, maybe those cuts are still in play. July, questionable, but at least, you might get one or two between now and the end of the year, timing when. But I think that's the big takeaway for us and how we think about it.

BRIAN HESS: So the rate cuts are still on the table. I mean, markets are pricing about two cuts by year end.

JACK JANASIEWICZ: Yeah, I think that's probably right too.

BRIAN HESS: We're in agreement at that.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: You mentioned housing inflation. But it seems like the housing market itself is feeling the pinch of higher interest rates. And there's been a slowdown for minority low level in activity and pricing. So we've got that Case-Shiller data. I think it was last week, not a strong print for the month. And existing turnover in the housing market just remains at such—

JACK JANASIEWICZ: Frozen.

BRIAN HESS: --a low level. So that's not necessarily great from a growth driver standpoint. Manufacturing has been very volatile this year. There was the front loading before tariffs. Then things came to a halt immediately after liberation day, maybe some more signs of life on manufacturing more recently. So that's come back online.

But I guess what I'm leading you into here is, how badly do you think the US economy is slowing right now? Because I think that's one of the key things. As far as I'm concerned, we've got three sources of uncertainty. The one is, obviously, the tariffs. We have no idea what we're going to be looking at from a tariff standpoint a year from now.

The second one, it's gaining clarity. But we're still not sure on the Big Beautiful Bill moving its way through Congress and what kind of stimulus that will provide to the economy. And then the third factor is, just how badly are we slowing in the backdrop against all this?

Because you can end up in a very different outcome if we have high tariffs, something goes wrong with the bill, and the economy is already inherently-- or it's slowing badly, versus tariffs are not a big deal. They're just a negotiating tactic. The bill sails through. And actually, the economy was quite resilient anyway. The path for rates could be very divergent.

JACK JANASIEWICZ: Sure. Yeah. And my guess is that, at least the way we're thinking about it, probably the combination of those two.

BRIAN HESS: [LAUGHS]

JACK JANASIEWICZ: So how about that for an answer?

BRIAN HESS: So we're in the middle.

JACK JANASIEWICZ: No, but I think-- listen. I think what's more probable in here, I think the labor market does continue to cool at the margin. So if we think about the big driver of the economy, it's consumption, a cooling labor market. And, again, higher tariffs means lower real income, which probably dents consumption at the end of the day.

Again, the question is, how much? I still think any way you slice this, we are cooling. It's just a question of, do we cool enough, where that spooks people? Or are we cooling just at the margin, where everybody's like, oh, I guess we can handle this? It remains to be seen. But it's something we're certainly paying attention to.

BRIAN HESS: And the path for us is still towards slower growth.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: Now, I think for our last topic, let's just hit on tariffs and just do a quick update. There's been so much that's gone on since early April. Before we wrap up, Jack, let's just touch base on tariffs. A lot's gone on since liberation day. There's been definitely a pullback in terms of the level and the vocalness around tariffs.

But they're still out there as a key issue driving markets. What are your latest thoughts? What do you make of, I guess, May's developments after the volatile month of April?

JACK JANASIEWICZ: Yeah, I mean, we just put a piece out this morning, talking about our thoughts in terms of  the tariffs are being challenged in the courts. I think, at the end of the day, they're still going to get implemented. It's just going to go and be implemented from a different set of policy initiatives. So they're still going to be in play.

BRIAN HESS: Different pathways—

JACK JANASIEWICZ: Yes.

BRIAN HESS: --to gaining approval.

JACK JANASIEWICZ: But I think, in general, the way we look at it is, OK, where are we maybe three, six, nine months from now, trying to play off of these daily headlines, where you're going to get run over? So I think where we fall on this is that, one, you're probably still going to see a 10% base tariff across the board. And I think that's simply because the US government needs the revenues from that. So that's probably going to be on there, so we can count on that.

Two, I think you can certainly expect maybe a higher level of tariffs on China. Now, 145%, that's a trade embargo. That's not going to happen.

BRIAN HESS: Nothing's moving—

JACK JANASIEWICZ: You can't do that.

BRIAN HESS: --at that level.

JACK JANASIEWICZ: Maybe we get something, the 25, 35. I don't what the number is. But I think in addition to the 10% across-the-board tariffs, China gets a little bit something extra on there, but again, not prohibitive to a point where we shut down trade.

And then the third piece on that, I think, still comes back to the idea of national security issues. And that just simply is the sectoral tariffs, the Section 232 tariffs. And that's more for national security purposes, just try to bring some of the things that we need back onshore. And that's part of the Industrial policy I think they're targeting.

So if I look at this in general, a 10% tariff across the board, think about where we are with regard to corporate margins, all-time highs. So for them to absorb some of that I don't think is terrible. Can you pass some of that on to the consumer, and we'll still be able to handle that? I think so too.

So I guess in general, if we get to that point we just outlined, I don't think that's really that prohibitive, that much of a headwind, especially to corporate earnings, where we're going to have a problem with the equity markets. So I think those are levels that we can live with going forward.

And quite frankly, I think the market can grind higher if that ends up being the case. We've just got to get to that point. And that could be three months from now or six months from now until we get to that point. But again, I think that's the approach. You have to look all the way out, not necessarily day to day here with the headlines.

BRIAN HESS: So a pathway is building. Maybe even you could make a probable case that the tariffs become not a major issue for the economy and for markets. And the reconciliation bill passes, and you get the tax cuts. And so those two sources of uncertainty become tailwinds—

JACK JANASIEWICZ: Sure.

BRIAN HESS: --which could offset any kind of slowdown we're seeing in the economy.

JACK JANASIEWICZ: We've always said this. It's give corporate America the rules, and they'll figure it out. They just don't know what the rules are right now. So just get rid of that uncertainty. And I think, even if we have tariffs, not the greatest backdrop, per se. But as long as we know the rules by which we're playing, I think then we can move forward.

BRIAN HESS: Well, maybe we'll get more clarity on the rules over the next month. And the next time we sit down and have a chat, we can discuss them. Thanks a lot, Jack. It was a great conversation.

JACK JANASIEWICZ: Always a pleasure, Brian. Thanks.