The calm before headwinds?
Recent developments – such as the ‘controversial’ latest US unemployment figure, geopolitical tensions and structural changes in US monetary policy – point towards a potentially volatile second half or year-end in the markets.
Uncertainty over the trajectory of the US economy has deepened after the release of the latest July employment report, which stood out for its weakness. It was one of the biggest negative macroeconomic surprises in nearly fifty years, reinforced by the sharp downward revision of the previous month’s figures. The probability of stagflation – characterised by sluggish growth and high inflation – has risen. An increasing number of analysts expect a marked slowdown in US growth in the second half of the year, as tariffs begin to weigh on the economy. The US could enter a “slowdown” or “stagflation” scenario by the end of 2025, though the possibility of a “cyclical recession” has not yet been completely ruled out.
The significant downward revision of job creation in June and May – down by 258,000 – is a typical sign of a pronounced slowdown.
“The stagflation context should be only a rather temporary phenomenon,” explains Enguerrand Artaz, Strategist at La Financière de l’Échiquier (LFDE). “The greatest risk, in our view, is that of a classic deflationary recession. The poor July 2025 employment figures (published on August 1) reflect the increasingly worrying deterioration of the US labour market and the risks this entails for consumption and growth.”
Artaz does not expect a prolonged period of stagflation but rather a classic deflationary recession.
“Faced with the looming economic slowdown, rising prices (temporarily driven by tariffs) should further erode household purchasing power, depressing demand. This situation should fairly quickly lead to stagnation, and possibly even falling prices as demand contracts. Stagflation should therefore only be a transitory phenomenon. The main risk, in our view, is that of a classic deflationary recession.”
90% probability of a rate cut in September (according to brokers)
At Amundi Investment Institute, stagflation is not ruled out, but recession remains the most immediate concern, according to Guy Stear, Head of Developed Markets Research:
“The pronounced slowdown in labour demand reflected in the US employment report should ease wage and price pressures, giving the Federal Reserve the necessary room to cut rates.”
Indeed, Fed Chair Jerome Powell reiterated during the last policy meeting that only a deterioration in employment would prompt him to ease rates. While the latest data do not point to an imminent catastrophe, they do support hopes for a more accommodative Fed stance.
Stear adds:
“This report strengthens the case for higher recession risks rather than stagflation. The still-low unemployment rate of 4.2% reflects a contraction in the labour force, probably due to restrictive immigration policies. Stagflation is possible if the economy slows because of supply constraints – not demand weakness – and policymakers misread the situation, responding with rate cuts and fiscal stimulus. In that case, tariffs could further fuel consumer price increases. In short, while recession remains the most immediate concern, the stagflation scenario cannot be ruled out.”
A figure that also sparks controversy
Christopher Dembik, Strategist at Pictet Asset Management, remains confident in US growth but also comments on the contested revision of previous months’ figures in the July report:
“The Trump Administration is wrong to claim the employment figures have been manipulated. However, it is true that the downward revisions for May and June are unusual. Such revisions sometimes occur due to weather events, but that was not the case. Nor are they linked to seasonality, low survey response rates, or changes in the BLS models to better reflect demographics. It appears there was an issue with the collection of administrative data covering job creation in the public sector.”
One possible explanation for the sharp revision in June’s job creation is that small businesses – more sensitive to the economic cycle – are slower to submit their responses to the Department of Labor’s surveys. Dembik concludes:
“In any case, it is too early to question our central scenario for the US economy: inflation slightly above target, without being worrisome, and growth remaining close to potential.”
The bond market reaction
According to DNCA, a specialist in fixed income investments, the reaction of the bond market to the July unemployment figure reflects more a fear of slowing growth than of higher inflation. Yields on the 10-year US Treasury have fallen to around 4.2%, down from 4.5% just a few weeks ago.
DNCA believes that the release of the July figure finally opens the way for a Fed rate cut before year-end. The market is already pricing in between two and three rate cuts by December, for a terminal rate (3-month in 3 years) around 3% to 3.25%, broadly in line with the Fed’s own projections.
The firm favours the long end of the yield curve. Paul Lentz, Fixed Income Analyst at DNCA, sees little left to gain on short rates, particularly as a slight inflation uptick caused by tariffs could disrupt short maturities.
An eye-catching VIX index…
Finally, the VIX index – the so-called fear gauge – fell to 14.4 on August 13, its lowest level since mid-December, indicating a certain complacency in the market and signalling investor confidence in the months ahead, in a period of optimism and stability.
