From Surveys to Spending: Following the Stagflation Trail
From Surveys to Spending:
Following the Stagflation Trail
The latest US economic data and market commentary point to a troubling mix of slowing economic growth and rising inflation – a classic stagflationary profile. The combination is being fuelled by tariff impacts, labour market frictions, and policy uncertainty, each amplifying the other’s effects.
The US services sector – traditionally more insulated from global tariff shocks – has shown signs of strain. The Institute for Supply Management (ISM) Services PMI is a monthly survey by the ISM that measures economic activity in the services sector. A reading above 50 indicates expansion and a reading below 50 indicates contraction. The index slipped to 50.1 in July, narrowly above the threshold that separates expansion from contraction, but notably below its long-term average. Weaknesses were evident across business activity, new orders, and inventories. Although still nominally in growth territory, the sector’s momentum has slowed considerably.
One of the most noticeable developments is the acceleration in services inflation. The ISM Services Prices Paid index surged to its highest reading since October 2022, with tariffs cited as a key driver. Yet, inflationary pressures in this space predate the latest tariff measures – price increases have been building steadily since 2021. This suggests the inflation story is not purely a tariff phenomenon but reflects more entrenched cost pressures, including wage growth and supply chain stickiness.
Initially, many companies resisted raising prices, relying on pre-tariff inventories. But with stocks running down and no sign of tariff relief, the inflation passthrough may begin to accelerate.
Red and Green – Both Flashing Amber for Growth (Gross Domestic Product – GDP)
Source: Artorius, Bloomberg
At the same time, the US labour market is losing momentum. Nonfarm payrolls, which tracks the number of paid workers across US economy (excluding farm employees and other areas such as those employed by private households or who are active military service members), provides one of the clearest snapshots of employment health. Annual payroll growth shows payrolls increased by just 73,000 in July, which was the weakest monthly gain since 2021. Downward revisions to previous months’ figures further underline the slowdown, and the chart on the right hand side shows that year-over-year growth has now slipped well below its pre-COVID range, in line with historically low rates of economic expansion.
This weakening in job creation is happening despite continued inflationary heat in key areas, leaving the Federal Reserve (Fed) facing a highly uncomfortable trade-off between holding interest rates or cutting interest rates. Current market expectations now state a 90% probability for a September interest rate cut – up sharply from 60% in May.
Payroll Growth Crawls to Post-2021 Low
Grey Bar – excluding covid recession and recovery
Source: Artorius, Bloomberg
When Borders Tighten, Prices Rise
Adding to these pressures, the current inflationary environment is being exacerbated by supply-side constraints arising from immigration policies. Construction Dive, an online publication specialising in topics such as labour and infrastructure, reports that heightened enforcement and deportations have disrupted construction sites. This has caused longer call-outs and delayed deliveries on various projects, such as student housing developments and primary schools. At the same time, CNN has reported how such policies have choked production in agriculture, leaving crops unharvested and a weakening in food supply chains.
According to the American Immigration Council, undocumented immigrant workers are heavily concentrated in sectors such as construction, agriculture and hospitality, where they make up 13.7%, 12.7% and 7.1% of the workforce. The construction sector is particularly at risk, not only because of its reliance on immigrant labour but also due to wage disparities. As lower-paid labour is lost, employers may have to raise wages to attract replacements, further driving up project costs and, by extension, housing and infrastructure prices.
Rate Cuts are On the Horizon…
The Fed is caught in a policy dilemma - prioritise controlling inflation through keeping interest rates high, or support growth via cuts. While tariffs, a weaker dollar, interest rates on hold and labour shortages point to higher inflation, weak jobs data and slowing output make the case for easing interest rates. Some Fed officials, notably newly appointed Stephen Miran, are sceptical about tariff-related inflation passthrough and advocate sizeable interest rate cuts. Markets expect two to three interest rate cuts by the end of the year, with the possibility of additional cuts if inflation comes in lower than forecast. However, Powell’s “wait-and-see” stance reflects long term uncertainty over how the tariff burden will be distributed between consumers and corporate margins.
Markets Price In More Fed Interest Rate Cuts Through 2025
Source: Artorius, Bloomberg
Political pressure is also adding another layer of complexity. The Trump administration has been vocal in urging the Fed to cut rates more aggressively to stimulate growth ahead of the election cycle. This has heightened scrutiny of Powell’s caution, with speculation mounting that a change in leadership in 2026 – when a new Fed Chair is appointed – could bring in someone more likely to side with the Trump administration’s preference for looser monetary policy and deeper interest rate cuts. Such a change at the helm could mark a significant shift in the Fed’s long-term approach to interest rates.
For investors, the environment is one of heightened uncertainty and bifurcated risks. In the US, short-term interest rates are likely to fall, and shorter dated Treasury yields have been supported on prospects for Fed easing. Equity markets remain supported by AI-driven investment and productivity gains, but cyclical sectors exposed to tariffs and wage pressures may underperform in the future. Globally, it remains favourable to maintain diversification until the US shows clearer signs of emerging from its stagflationary phase. Within this, favouring sectors that have the ability to raise prices without losing customers can help protect returns in this current environment.
Mark Christie
Investment Analyst
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