For all the worries about the impact of US tariffs on growth and inflation, recent data shows the US economy to be still in good shape.
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US industrial production growth rose from 0.0% to 0.3% in June compared to market expectations that it would not rise at all. Retail sales excluding cars and fuel gained 0.5%, beating expectations and improving on the prior month’s reading. Non-farm payrolls increased by 147,000, more than in May and better than forecast. Finally, core inflation, while reflecting some impact of the US’s import tariffs, rose by less than the consensus expectation.
Equity market returns have reflected this. The tech-heavy NASDAQ 100 index gained 1.8% in the first weeks of the third quarter, which was double the advance for the Russell 1000 Value index, but below the 3.7% for the Russell 2000 index of small-cap stocks. We expect good results in the coming corporate earnings season, which should support additional gains in the indices.
It is exactly when markets appear so content (both the VIX and MOVE indices, which track expected volatility in stocks and bonds, respectively, are below average), that one should begin to worry.
The first thing to consider is that not all the economic data has been as positive as portrayed.
Employment data cast doubt on growth potential
Half the increase in June’s non-farm payrolls was in the government sector; private payrolls rose by far less, by just 74,000, which was well below the 121,000 average over the preceding year.
Moreover, the vast majority of the jobs that were created were in the healthcare and social assistance sector (see Exhibit 1). While certainly valuable, these jobs are more curative/administrative than productive, raising doubts about the economy’s longer-term growth potential. This imbalance is not new – it has been evident for at least a year.
And while retail sales did improve, the average gain over the second quarter of 2025 was lower than in the first quarter (see Exhibit 2). This is worrying as the personal consumption expenditures (PCE) component of GDP rose by just 0.1% in the first quarter, marking the slowest pace since the Covid pandemic. It is also far below the rate in 2024.
Some deceleration in consumer demand was expected this year as excess household savings were run down, but this appears to be happening rapidly. The retail sales figure for the second quarter suggests that consumer demand – the primary driver of US growth – could again be poor when second-quarter GDP figures are released at the end of July.
Tariffs and demand
This weakness in consumer demand could be exacerbated as tariff price increases show up more and more in the shops. The impact of the tariffs so far has been modest: year-on-year core inflation rose from 2.8% to 2.9% in June, but remained below the 3.1% rate seen in February.
The inflation sub-indices that gained the most, however, are those where the tariff impact would be expected to be the highest, for example, appliances and clothing.
As prices rise further, consumer demand could falter.
To what extent this will happen, however, is unclear. Where domestically produced, cheaper substitutes are available, consumers may simply switch, meaning that even if prices rise for some goods, there would be little or no impact on the prices actually paid by individuals.
In addition, prices may not go up by as much as the tariff being applied if producers or retailers opt to absorb some of the cost. And in any event, imported goods account for just 11% of US consumption, according to a 2019 study by the Federal Reserve Bank of San Francisco.
Tariffs and earnings
The financial market’s contentment appears to be partly premised on the assumption that the latest threats from President Trump of yet higher tariffs will not be implemented, most likely because key trading partners such as the EU will make sufficient concessions to make the threatened tariffs unnecessary.
If this turns out to be the case, US equities could get a further boost as these concessions could entail improved market access and/or lower tariffs for US exporters.
The earnings reporting season has started well, with 7% earnings surprises so far according to analysis by Factset.
Just as importantly, the mood among CEOs is good, with the share of positive guidance on future earnings above average and rising. This is in contrast to the first quarter, particularly after the ‘Liberation Day’ tariff announcement, when sentiment deteriorated sharply (see Exhibit 3).
It is worth bearing in mind that import tariffs are positive for at least some US domestic producers. And even for those who suffer from the levies, there may be other – sufficiently positive – factors such as deregulation, lower energy prices, and mergers and acquisition opportunities to keep them optimistic on the outlook.
Sell America?
The Trump administration’s unorthodox economic policies have prompted some investors to question the appeal of US assets, from equities to Treasuries and the dollar.
There are doubts about the long-run growth prospects of the economy and the willingness of the government to pay back its significant debts to bondholders. The US counts on foreign investment to finance its large current account deficit.
There was some evidence of this change in foreign investor sentiment in the April foreign flows data, which showed a rare month of net sales of US assets. The redemptions were large in absolute terms, though not so significant as a percentage of total foreign holdings of US securities.
The most recent data, however, paints a rather different picture. Not only did inflows into US assets resume in May, but the total for the month was the highest ever, partly thanks to significant inflows from Canada (see Exhibit 4).
This includes purchases not only of US Treasuries (at a 4.4% average yield for the month versus 4.3% in April, so investors were not being attracted by a meaningfully higher yield). It also includes equities, indicating a high level of investor conviction in the ability of US corporates to continue generating superior earnings growth in the future.
