Economics Update July 2025 - USA: Is a hot summer looming?

The at least temporary easing of the major geopolitical conflict between Israel and Iran involving the USA is drawing attention back to two issues that have recently lost a lot of attention: the customs issue and the US budget planning for the coming years. And the US Federal Reserve (Fed) is in a difficult situation right in the middle of this.

Tariff policy: higher tariff levels harbor inflation risks

The United States' trade agreements with the UK and the successful negotiations with China have been received positively, particularly on the stock markets. An agreement may also be reached with important trading partners such as the European Union (EU) and Japan. Nevertheless, there is no reason for general euphoria: the general level of tariffs on US imports will ultimately be at least three times higher than before Trump took office. And this president can hardly be expected to make tariffs irrelevant to his policies in future. The foreseeable immediate consequence will be rising import prices and thus rising inflation rates. There is little evidence of this in the data available up to May, but ultimately either consumers will have to pay the tariffs in the form of higher consumer prices or companies with lower profit margins. The price component of the purchasing managers' index recently climbed to its highest level in three years. That shows: There is trouble looming in the background.

Fiscal policy: Higher debt further erodes the sustainability of state finances

Trump wants to sign the “One Big Beautiful Bill Act” (OBBBA) in time for the national holiday on July 4. If the Senate and House of Representatives succeed in reconciling the existing drafts, this could work. However, one thing is clear: the annual deficits in the US budget are likely to remain large in any case - and the debt level will continue to rise. Experience shows that players on the stock markets will initially be pleased with the tax cuts contained in the OBBBA, while their colleagues on the bond market are likely to react to the further erosion of the government's debt sustainability with higher interest rate demands for US government bonds. A further rise in interest rates would in principle be problematic for the economy, as can already be seen in the development of the housing markets and construction activity. Data on consumer spending is also showing the first signs that US Americans are no longer in an unreservedly positive mood.

Monetary policy: Fed in a dilemma

In this mixed situation, the Fed with its dual mandate - price stability and maximum employment - finds itself in a difficult position: in view of the foreseeable inflation trend, interest rate cuts are out of the question, but in view of the expected economic development, they would certainly be desirable. Officially, the central bankers are keeping both options open. Behind the scenes, however, there is apparently a fierce debate about the extent to which tariff-related inflation effects should be regarded as “temporary” - which could pave the way for interest rate cuts. Meanwhile, the President is publicly insulting the head of the Federal Reserve, whom he himself appointed, in a way that raises fears of the worst for the future independence of monetary policy decisions. The politicization of the Fed in the service of the MAGA movement has the potential to fundamentally shake the capital markets. The intention to install a kind of shadow president now, barely a year before the end of Powell's term of office, has already increased nervousness on the markets.

Conclusion: No summer calm in America (and the rest of the world)

There are exciting days and weeks ahead, and a real summer break is unlikely on the US markets. As US equities, treasuries and the dollar still have a dominant influence on world events despite the loss of confidence already suffered, this also applies to Europe and other regions around the world.