A Sniff Of Stagflation Stalls The Rally

The S&P 500 fell for the third day in a row, despite Microsoft and Meta Platforms rising on strong earnings results, as investors seemed more concerned about today’s deadline for “reciprocal” tariffs. I have been concerned that the reality of tariffs would start to overshadow AI euphoria as this day approached. The president is expected to sign an executive order that imposes new tariff rates on all trading partners effective today, with the exception of the EU, UK, Japan, and South Korea. Those countries struck the framework for agreements. The president already announced unilateral rates on India and Brazil, while Mexico has been granted another 90-day extension, and China seems to have one as well. Now that we hopefully have a degree of certainty on trade policy, investors will refocus on the economic data.

The Fed’s preferred inflation gauge rose 0.3% in June, which resulted in the personal consumption expenditure (PCE) price index increasing at an annual rate of 2.6% compared to 2.5% in May. The core rate, which excludes food and energy, also rose 0.3%, resulting in no change in the annual rate of 2.8%. Last month’s inflation was fueled by price increases for goods, which included clothing, household goods, and recreational equipment. The PCE for goods rose 0.4% last month. There could be some offset from PCE services, which rose just 0.2% last month, but the overall trend is no longer our friend. That will dissuade the Fed from cutting interest rates in September.

Some have asserted that there is no inflation today, but the chart below portrays a different picture. The core rate of inflation (PCE) has risen from 2.6% in June 2024 to 2.8% in June 2025. The disinflationary trend has come to an end by this metric, and I expect we will see the core PCE rise above 3% over the next few months, which will be the highest rate in two years. This is not catastrophic, but it will adversely impact real income and real personal spending.

We also learned yesterday that real disposable income was flat in June, while real personal spending rose 0.1% to round out two of the softest quarters in consumer spending since the pandemic. Purchases of durable goods fell for a third month in a row. To remove the noise in the monthly numbers, I prefer to look at inflation-adjusted (real) consumer spending growth on a year-over-year basis. By that metric, we are still holding above 2%, but the rate of growth has slowed demonstrably over the past year. This accounts for 70% of our overall economic growth.

I think a rising rate of inflation combined with very sluggish consumer spending is going to stall the stock market’s rally between now and the next Fed meeting, as investors grow concerned over a transitory period of stagflation. Our stock market is priced for perfection, but the macroeconomic backdrop is far from perfect right now. This is not a call for a bear market or a recession. It’s a major speedbump on our way to a soft landing at this stage. It is one that I think could result in another market correction that tests the long-term moving average for the S&P 500, which sits at 5,900. Provided economic growth sustains, price increases are temporary, and the labor market holds up, it should be another buying opportunity in the bull market that started in October 2022.

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