Upheavals

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Greater than the Some of its Parts

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Soundbite: The bulls are celebrating that the inflationary effects of tariffs have yet to be felt. Paradoxically, the more delayed the tariff impact, the more dangerous it is for the economy and global asset prices. What triggers the Fed to tighten or ease policy will be whether tariffs lead to higher inflationary expectations. Companies could prolong tariff increases by passing through price hikes incrementally, which could cause inflation expectations to intensify because price rises are layered in over time. If tariffs are raised repeatedly, it will enforce the view that more price hikes are ahead, and inflation becomes ingrained in consumers’ outlook. This scenario, where companies take their time to fully raise prices, is gaining acceptance within the FOMC. That would lead the Fed to pivot and begin discussing higher policy rates. With markets pricing six rate cuts through next year, investors may need to completely reverse their forecasts and reprice risk assets. 

St. Louis Fed President Alberto Musalem, a voting member of the Federal Open Market Committee (FOMC), cautions that the full impact of tariffs may not be known until Q1 2026, “where tariffs are still working themselves into the economy.” This certainly is a reason for Fed patience, a sentiment repeated in the June FOMC minutes:

“…it might take some time for…higher tariffs to be reflected in the prices of final goods because firms might choose not to raise prices…until they had run down inventories of products imported before the increase in tariffs or…it would take some time for tariffs on intermediate goods to work through the supply chain.”

Alternatively, another scenario where Musalem’s 2026 forecast plays out is if firms end up stretching out tariffs by gradually increasing prices throughout the year to prevent sticker shock. Chair Powell has repeatedly rejected this scenario. He has outlined a Fed consensus where tariffs are a one-time price increase that policymakers can ignore. Meanwhile, the minutes paint an entirely different picture:

“While a few participants noted that tariffs would lead to a one-time increase in prices and would not affect longer-term inflation expectations, most participants noted the risk that tariffs could have more persistent effects on inflation.”

This reality has gone undetected by the bulls. Investors are buying based on a scenario where rising inflation and higher inflation expectations are unlikely because tariffs will be a one-time event that consumers can quickly put behind them.

Again, from the minutes: “Some participants…see…the risk of elevated inflation as remaining more prominent…than risks to employment [and] some highlighted the fact that such persistence could also affect inflation expectations.” While “some” in Fed-speak is short of a majority, there is a growing number of FOMC participants that already expect tariff risks are drawn out until next year and will lead to higher inflation expectations, resulting in higher interest rates. Some investors are beginning to question what could ever turn the stock market lower, and this is one recipe that could collide with bullish sentiment.

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Dear Mr. BRICS

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Soundbite: Raising tariffs to 50% on Brazil, a country that runs a trade deficit, not a surplus, with the U.S. seems irrational. Secondly, our thinking was that Latin America had been spared onerous tariffs so far because it fell under a renewed doctrine of spheres of influence. Slapping outsized tariffs on Brazil pierces the view that Latin America is under our umbrella. However, the administration is pushing back against the growing influence of the BRICS alliance. It could also be a strategy to create economic hardship in Brazil to bolster the chances of a conservative party win in the upcoming presidential elections in October 2026. However, this pressure risks yet another step away from globalization, reinforcing structural upward inflation pressures and creating even more uncertainty regarding tariff resolution.

While the headlines are focused on static that the Bolsonaro trial was a major factor behind putting China-level tariffs on Brazil, President Trump said during the BRICS Summit last week that “Any country aligning themselves with the anti-American policies of BRICS will be charged an additional 10% tariff.” Brazil is the only country in the U.S. sphere that is a complete member of BRICS, with Bolivia and Cuba joining as partner countries. The U.S. may be drawing a less than subtle line in the sand to warn other South American countries from joining.

The BRICS summit released a statement detailing serious concerns about “the rise of unilateral tariff and non-tariff measures which distort trade.” The relentless series of punitive trade announcements from Washington could complicate trade negotiations even more as it plays into the BRICS agenda to pursue trade deals outside of America.

The Summit’s 31-page declaration highlighted the BRICS Cross-Border Payments System designed to create “low-cost…efficient…safe cross-border payments among BRICS countries…which can support greater trade and investment flows.” According to Jeffries, China has signed currency swap agreements with 40 countries, and Renminbi-denominated goods trade has doubled over the last four years and is approaching 30% of total trade through May of 2025.

The administration hopes that Latin America’s large economies will shift to the center-right following elections next year in Brazil, Chile, Colombia, and Peru. Argentina’s election of Javier Milei started this movement that Washington hopes will spread. Argentina was scheduled to join BRICS, but Milei reversed course, and Argentina escaped higher tariff treatment. Brazil’s 50% tariffs will hurt the economy and could push voters away from Lula’s Workers' Party toward the center-right. Pave has published a note on the investment implications of the Continent’s conservative shift (Link Here).

A free trade environment among BRICS countries could affect trade discussions with the U.S. by making countries more resolute to retaliate and less likely to be forced into deals. In our first Point above, we mentioned that inflationary expectations are sensitive to the timing and duration of tariffs, and in turn could change Fed policy. Considering the increase in Mexican, Canadian, and E.U. trade tariffs this weekend, we are looking to see if those countries open more serious discussions with China and other BRICS countries. Again, the more alternatives our main trading partners have, the worse our negotiating position becomes. This increase in uncertainty may be seen as a short-term opportunity to buy the dip, but over time will expand equity risk premiums.

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AI: The More Things Change, the More They Change

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Soundbite: No one knows how quickly AI will become reality, whether it will displace entry-level jobs or seasoned employees, or how deep its impact will be on employment, federal deficits, or even college curricula. Investors used to take solace in the fact that these issues would be resolved far in the future, but deployment is unfolding fast, and markets will be forced to make decisions outside of simply funneling capital to the Magnificent Seven.

Have we arrived at the “Right Here, Right Now” stage of artificial intelligence? Last week Goldman Sachs announced it is implementing software from AI start-up Cognition to function as digital programmers. It will begin by upgrading internal programs to improve productivity, but could eventually run as autonomous full-stack engineers. This is another step in the evolution of AI adoption and serves as a major leap beyond helping employees organize email. Goldman hopes this new tool will increase worker productivity more than three times the rate of AI tools presently used at the bank.

Granted, the level of uncertainty is high. Academics are split. UC Irvine researchers found that more senior coders used AI to review the output of more junior developers, helping the managers’ productivity. The payroll firm ADP supports this finding. Their data shows that customer service representatives and programmers with less than two years' experience have seen a 25% drop in employment since 2023, but demand increased for workers with more experience.

However, Microsoft found that coding assistants, such as those being rolled out at Goldman, can increase a junior developer’s productivity more than a more senior employee.

Regardless of which theory plays out, we believe that the drop in employment reported by ADP could be part of the general realization that fewer employees will be needed in the AI Age, a realization that could be behind the tariff rollout (replacing lost income tax revenue).

For now, investors have taken the low hanging fruit, taking NVIDIA to a $4 trillion market capitalization. However, in May, we saw a potential DeepSeek 2.0 event when the stablecoin issuer Tether announced plans for a 2025 release of a decentralized AI architecture that does not rely on centralized servers, ending the need for data centers. The software will run on user devices such as smartphones. Investors will need much more evidence before hitting this generation’s must-own stocks, but it is a reminder that nothing is guaranteed in the coming AI rollout.

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What to Look for This Week

(All times D.S.T.)

1. Wednesday, July 16 at 8:30 a.m. June Producer Price Inflation. Wednesday’s inflation report should be a more important datapoint than CPI out on Tuesday July 15, because PPI is where tariffs should show up first. We will be focused on Final Demand Goods PPI, which accounts for one-third of the overall index. Core Goods Final Demand, excluding food and energy will also be an important metric. For Tuesday at 8:30 a.m., annual Core CPI inflation has been 2.8% for the last three months, but the Cleveland Fed Inflation Nowcast is for June to come in near 3%. Fed Chair Powell and other FOMC voters said the tariffs could start being seen in data as early as June, so CPI and PPI could be market movers.

2. Wednesday, July 16 at 7:00 a.m. MBA Home Purchase Index for July 11 is out after last week hitting a high not seen since February 2023. This contrasts with Friday July 18 June Building Permits at 8:30 a.m., which hit a low not seen since June 2020.

3. Thursday, July 17 has a number of key data releases. At 8:30 a.m. Initial Jobless Claims for July 12 has seen 4 consecutive drops, so the 4-week moving average has also been falling, in contrast to Continuing Claims, also out 8:30, just hit the highest level since November 2021. In addition to the July Philadelphia Fed Business Conditions Index (watch the employment subcomponent that fell toward post-pandemic lows last month) June Advance Retail Sales are also released at 8:30. Consumer Spending fell for the past two months but is expected to rebound. Importantly, at 4:00 p.m. Net Foreign Buying of U.S. Treasury Purchases fell sharply in April toward 4-year lows, so the May print is significant.

FOMC Voters Speaking: Wednesday, July 16 at 2:00 p.m., the Fed’s Beige Book for the July 28-29 FOMC meeting is released. Let’s start by going to the end first: Governor Christopher Waller speaks on Thursday, June 17 at 6:30 p.m. on the Economic outlook, the last voter to speak before the two-week blackout period begins. Tuesday, July 15 at 9:15 a.m. Fed Governor Michele Bowman speaks. She is probably the other voter with Waller who advocates a July cut. Wednesday, July 16 at 10:00 a.m. Governor Adriana Kugler speaks on Housing and the Economic Outlook followed at 4:30 p.m.by NY Fed president John Williams. Thursday, July 17 Governor Cook speaks on AI and Innovation.

Earnings Season: Tuesday July 18: JP Morgan, Wells Fargo, Citigroup and BlackRock all before market open. Wednesday July 19: Bank of America, Goldman Sachs, Morgan Stanley, and ASML all before market open. Thursday July 17, Taiwan Semiconductor before market open and Netflix after market close. Friday July 18 American Express before market open could give insight on higher income consumer spending.