On the surface, the United States (US) economy still looks sturdy. Growth is holding, inflation prints are calm, and equities are climbing. But beneath the surface, the story is far more fragile – the economy is balancing on a shaky foundation of temporary boosts, delayed price pressures, and a labour market that is losing its footing.
The latest Wall Street Journal (WSJ) Economic Forecasting Survey still pegs recession odds at about 33% over the next year. While that is lower than the April peak, it is hardly a figure that signals strong building blocks. The US Treasury and Bank of America survey agreed with the WSJ’s 33% chance of recession, while the New York Federal Reserve’s (Fed’s) own model sits just shy of 30%. And the Conference Board’s Leading Economic Index has now fallen three months in a row – historically one of the most reliable early-warning signals.
The growth that looks so solid in the gross domestic product (GDP) tables is not as organic as it appears. Much of it comes from companies rushing to stockpile goods before the next round of tariffs hit. It is the kind of behaviour that can make one quarter look strong and the next one limp. We’ve seen it before. In past tariff cycles, inventories turned from an economic tailwind to a drag almost overnight.
Inflation data is also deceptive. Both the Consumer Price Index (CPI) and the Personal Consumption Expenditure (PCE) Index are backward-looking. They don’t yet reflect the second-round effects of tariffs – from rising input costs to altered supply chains – that will show up later in the year. The New York Fed’s Survey of Consumer Expectations has five-year inflation views edging toward 2.9%, suggesting households are starting to price in stickier inflation than the headline numbers imply.
The US labour market, however, is where the cracks are clearest. Payroll gains are slowing, unemployment is edging higher, and job openings are shrinking. If the US economy was expanding as broadly as the GDP numbers suggest, we would not see this kind of strain in hiring. Instead, it hints at an expansion that’s narrow, concentrated in capital-heavy sectors and temporary pre-tariff activity.
Equities, though, seem blissfully unaware. The VIX Index (measuring volatility) sits near lows for the year, and the S&P 500 keeps setting records. Much of that strength rests on a handful of mega-cap names, with analysts still pencilling in roughly 10% earnings growth for 2025. The forward price-earnings (P/E) ratio sits near 22 – expensive by historical standards – leaving little room for disappointment. Goldman Sachs estimates that every five-percentage-point jump in effective tariffs could shave 1% to 2% from S&P 500 earnings. In 2018, a similar cost squeeze quickly forced analysts to cut forecasts when companies like Caterpillar warned of sharply higher steel costs.
Even the banks are starting to warn the markets. Morgan Stanley points to three trouble spots: slowing job growth (just 73,000 jobs added in July), the narrowness of earnings leadership, and creeping stagflation risk. That last point is gaining traction fast. The Financial Times says stagflation has moved from theoretical risk to active discussion, fuelled by weaker job data, slowing Purchasing Managers’ Indices (PMIs), sticky inflation, and tariffs averaging nearly 19%. A recent Business Insider piece described the current environment as “stagflation-lite” – not yet a full-blown 1970s rerun, but close enough to make markets uneasy.
That unease is starting to show in surveys. A Bank of America fund manager poll in August found that 70% expect stagflation within a year, and 91% believe US equities are overvalued. And while some market commentators argue that investors will only react when they “see the whites of the recession’s eyes,” as financial and investment news company, Barron’s put it, history shows that once sentiment turns, it can turn fast.
What history reminds us
History reminds us that inventory distortions have flipped sectors before. In 2023, markets saw inventory drag reverse a previous lift, shaving roughly 2.26 percentage points from US GDP in a single quarter. Unfortunately, volatility also does not hold back any punches; news agency Reuters highlighted that the aftershocks from extreme volatility can see the VIX take around 170 trading days to revert back to normal levels.
In addition, the current earnings and valuations don’t have much slack. Forward P/E of 22 is an elevated number. A modest earnings disappointment, via margin compression, cost shocks, or lower sales, could shift sentiment abruptly. In 2018, similar setups preceded swift downgrades when tariffs began to bite corporate margins.
If we pull all of the current data together, we see:
- Stagflation expectations are strong with 70% of fund managers and 60% to 70% of market watchers alert.
- Current US economic data is masking demand distortion, delayed inflation, a faltering labour market, and equity complacency.
- Earnings optimism and market valuations offer a limited buffer to any policy or cost shocks brought on by tariffs.
A holistic look at the US economy reveals that it isn’t just one indicator out of place – it’s the interconnected layering of a number of market risks. If history teaches us anything, it’s that when multiple red flags align, tipping points can arrive fast.
In summary
The US economy’s apparent resilience is being propped up by temporary boosts, delayed inflation realities, and market optimism that leaves little margin for error. The combination of a softening labour market, stretched valuations, and growing stagflation risk is not a comfortable one. When multiple warning signs flash at once, it’s rarely a good idea to ignore them. The numbers are telling a different story from the headlines. This time, the devil isn’t in the detail; it is in plain sight.
MARKETS IN A NUTSHELL
The week’s key themes:
- US Treasury markets wrestle with PPI surprise
- Indices largely flat after stellar week
- Gold losing ground, heading for its poorest week since late June
- Dollar continues its dance with inflation
Bonds
In the US, Treasury markets are wrestling with a stark inflation surprise, as the Consumer Price Index (CPI), released earlier this week, was in line with expectations, while Thursday’s Producer Price Index (PPI) indicated a three-year record jump in producer prices. The PPI print has wiped out hopes for an outsized 50-basis point cut from the US Federal Reserve (Fed) next month. The markets are now locking in a smaller move of a 25-basis point cut. US Treasury yields have drifted higher as traders recalibrate, with eyes now waiting for upcoming data releases and the Jackson Hole Economic Symposium for fresh guidance.
United Kingdom (UK) Gilts followed a softer path, yet stronger domestic growth and better labour figures have curbed the urgency for further Bank of England (BoE) rate cuts. The previous week’s narrow rate-cut vote underscored divisions amongst policymakers, especially with inflation proving sticky.
German Bunds have traded in a tight range near 2.6% for the week, held in check by modest euro-area growth, steady prices, and the shadow of US trade barriers.
In South Africa, long-dated yields remain anchored near multi-month lows following the central bank’s rate cut at the end of July. Investors are weighing a dovish tilt against the economic drag from the newly-implemented US tariffs of 30%, with the export-reliant auto sector most exposed.
Indices
US stocks have been locked in a holding pattern. Gains in select names – diversified health company, UnitedHealth Group, on heavyweight investor interest, and multinational technology company, Intel, on speculation of the US government buying a stake in the company to deepen its involvement in the US chip industry – have been offset by broader caution following the PPI shock. The S&P 500 and Dow barely moved, while the Nasdaq edged fractionally lower.
In London, the FTSE 100 stalled after three consecutive advances, as mining stocks and a clutch of major ex-dividend names weighed on the index. Resilient UK GDP and employment data gave UK financials some support, lifting insurers and banks.
Continental Europe enjoyed a more decisive move higher, powered by upbeat corporate earnings in sectors from aerospace to insurance. Optimism around trade discussions between Washington and Brussels, coupled with anticipation for today’s Trump–Putin meeting, lent further support.
South Africa’s equity benchmark, the JSE All Share Index, eased from recent highs, with traders reluctant to add risk ahead of clarity on how US tariffs on South African exports might affect key industries.
Commodities
Oil markets have been treading water. Brent has slipped back under $67/barrel after a short-lived bounce, as traders wait to see whether the Alaska meeting between the US and Russian presidents can deliver tangible progress on Ukraine. Washington has warned of sharper sanctions on Russian crude buyers if talks fail, keeping geopolitical risk priced in. At the same time, signs of stronger demand from Japan and the prospect of US monetary easing are acting as a counterweight to the Organisation of the Petroleum Exporting Countries’ supply expectations and demand-growth concerns.
Gold has been losing ground, heading for its worst week since late June, it is, however, marginally in the green this morning. The hotter US inflation print has shifted rate-cut forecasts toward a slower pace, dulling bullion’s appeal in the near term. Yet ongoing central bank purchases, including by China, and geopolitical uncertainty continue to provide support, with traders positioning ahead of next week’s Jackson Hole symposium.
Currencies
The US Dollar Index has steadied just above the 98 mark, buoyed by the sharp PPI surprise that has all but killed talk of a half-point September cut. Markets still expect the Fed to ease, but with less urgency, making upcoming consumer data and Powell’s Jackson Hole comments critical for direction.
The euro has held close to $1.16/€, caught between soft euro-area growth, stable inflation, and the drag of looming US tariffs on European exports.
Sterling moved to a five-week high near $1.36/£, lifted by resilient UK GDP and labour figures that have challenged expectations for more BoE cuts in the short term.
The rand has pulled back to around R17.60/$, giving up earlier strength as gold prices slipped and the greenback regained some lost ground. Domestic sentiment remains cautious, with stronger manufacturing output offset by weaker employment and unease over the long-term cost of US trade measures.
*Please note that all information and data is at the time of writing.
Key indicators
USD/ZAR: 17.58
EUR/ZAR: 20.51
GBP/ZAR: 23.81
GOLD: $3,341
BRENT CRUDE: $66
Sources: Barron’s, Business Insider, Conference Board, Financial Times, MarketWatch, New York Fed, Quartz, US Treasury and WSJ.
Written by: Citadel Advisory Partner and Citadel Global Director, Bianca Botes.