2025 Week 26

1. Record Tariff Revenues – Who Pays the Bill?

Net federal tariff revenue reached $60 billion in the first five months of 2025—nearly double the same period in 2024—thanks to a baseline 10% across most imports and higher duties on select sectors. Although import prices excluding fuel rose just 0.3% in May (0.8% year-to-date), this modest gain—despite tariffs—indicates foreign suppliers aren’t absorbing the added cost. A weaker trade-weighted dollar (down ~7%) further limits their ability to discount. This means U.S. importers and ultimately consumers are taking the hit through tighter margins or higher prices.

Key Takeaway: The fiscal windfall from tariffs has not been absorbed abroad—they are being passed on domestically, raising concerns about consumer burden.

2. U.S. Growth Resilience—Still Chugging Along

After a -0.2% GDP contraction in Q1, a tariff-fueled surge in imports skewed the numbers. The Atlanta Fed now estimates a solid +3.4% real GDP growth in Q2, implying ~1.6% growth for H1. Consumer spending is mixed: headline retail sales dipped 0.9% in May, but core sales rose 0.4% MoM and 5% YoY—signaling sustained household spending despite prior pre-tariff stockpiling.

Key Takeaway: Economic momentum remains intact for now, allowing the Fed to stay patient despite elevated rate levels.

3. Inflation: Tariff Effects Loom But Not Here Yet

Core PCE—a key Fed indicator—hit a four-year low in April, with May expected around 2.6%. Firms have used pre-tariff inventory and absorbed additional costs to shield consumers. But as older stock depletes, price hikes are expected. The Fed’s 2025 inflation outlook has shifted upward, from 2.8% to 3.1%. With effective tariffs near 15%—the highest since 1936—some goods price pressure is inevitable, though services inflation may soften and the bump could be temporary.

Key Takeaway: Inflation remains benign for now, but the true impact of tariffs is yet to hit consumer prices—and the Fed is on alert.

4. Fed Rate Outlook: Patience Into Summer, Then Cuts?

With GDP holding steady and inflation steady-ish, the Fed will likely pause. Yet, the median dot plot still includes two rate cuts in 2025, one in 2026, and one in 2027. Markets anticipate a ~3.2% Fed rate by end-2026 compared to the Fed’s ~3.6%. We expect a gradual, shallow easing path—similar to the mid-1990s—after summer, rather than recession-driven cuts.

Key Takeaway: Rate cuts may be delayed, but a slow unwind of restrictive policy remains in sight.

5. Geopolitical Risks: Watch Energy Prices

Escalation in the Israel–Iran conflict could drive oil spikes, fuelling inflation. But historical precedent shows oil jolts haven’t led to sustained market shocks. The U.S. remains a net petroleum exporter and energy’s share of GDP is smaller—suggesting any spike may be short-lived.

Key Takeaway: Geopolitical tensions pose a risk, but U.S. energy self-sufficiency offers some resilience.

6. Portfolio Strategy: Diversify Beyond the U.S.

Equities rose ~20% from April lows; near-term volatility may rise. With yields high and likely to stay elevated, 7-10 year investment-grade bonds offer income and volatility buffer. U.S. equity clarity—on tariffs or dollar direction—could prompt rotation back into domestic markets, but international equities, especially Eurozone, are attractive for earnings growth and valuation relative to the U.S. Within U.S. markets, financials and healthcare look promising. Balance exposure to growth and value styles.

Key Takeaway: A globally diversified strategy—combining bonds, international equities, and select U.S. sectors—can help manage policy and geopolitical uncertainty.

Looking ahead to next week: market focus will center on June’s CPI/PPI data, the Fed’s July meeting, and updates on corporate guidance as tariff pass-through begins to materialize.

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