by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment begins with an examination of why a degree of optimism about the economy remains warranted despite recent subpar economic data. We then turn to other key stories shaping the market, including our analysis of Tuesday’s Treasury auction, the president’s push to end the conflict in Ukraine, and the factors behind the recent surge in investment-grade bond issuance. Finally, we assess other major international and domestic developments impacting financial markets.

 US Services Stagnate: A survey of purchasing managers revealed that firms are still adjusting to the impact of tariffs. According to the Institute for Supply Management, services activity remained relatively unchanged from the previous month. Much of the weakness stemmed from a slowdown in employment growth as companies scaled back hiring. Additionally, the survey indicated that input prices continued to rise, while export orders showed signs of weakening.

• The recent report has dampened market sentiment, as uncertainty persists regarding the potential impact of tariffs on the economy. However, the economy continues to show resilience, suggesting that the current market rally still has significant momentum. This perspective is further supported by strong earnings from Disney, which reflect robust consumer spending in the travel and leisure sectors.
• That said, we maintain a risk-neutral stance for now, as we continue to assess the economic impact of tariffs. While we do not foresee an imminent recession, some signs of weakness may persist temporarily before fading as the fiscal stimulus takes full effect. Once there is clearer evidence of sustained economic resilience, we believe shifting to a more risk-on position would be warranted.

 US Bond Auction: The first of three Treasury auctions saw tepid demand. The $58 billion sale of 3-year notes closed at a yield of 3.669%, slightly above pre-auction levels. The results suggest that the supply of bonds is exceeding demand. This outcome may be a reflection of current market concerns, including inflation and US deficit spending, which can influence the appetite for government debt.

• This week will be crucial in gauging market appetite for US Treasurys. While auction performance can fluctuate, any sustained signs of weaker investor demand could pressure yields higher, reflecting diminished absorption of Treasury issuance.
• While a single auction does not define overall demand, sustained weak performance could establish a floor for yields, particularly if the Fed begins cutting rates. Should auctions consistently underperform, it may even prompt the Fed to halt balance sheet tightening earlier than expected.

 Italy’s Defense Bridge: Italian Prime Minister Giorgia Meloni is poised to approve construction of a bridge linking Sicily to mainland Italy, framing the 13 billion EUR ($15.1 billion) project as a boost to defense spending. However, the move has drawn criticism. While proponents argue the bridge would help NATO counter Russia’s expanding influence in the Mediterranean, detractors contend the funds would be better spent directly enhancing military readiness, such as upgrading ports, airports, and roads, to prepare for potential Russian aggression.

• Italy’s move to classify certain infrastructure projects as defense spending illustrates how European governments may redirect military budgets to fund domestic infrastructure priorities.
• We maintain confidence that the EU’s increased defense spending will provide a meaningful boost to the broader economy and, by extension, equity markets. This reinforces our constructive outlook on international stocks.

 Pharmaceutical Tariffs: The White House has unveiled plans to impose tariffs on pharmaceutical imports that could eventually reach 250%. While the duties would start at lower levels, they would gradually increase over 18 months until reaching the full rate. This move is part of the administration’s broader effort to incentivize domestic drug manufacturing and reduce reliance on foreign production.

 Russia Ready to Talk: Moscow has indicated its willingness to consider a potential air ceasefire in Ukraine as a means of meeting the White House’s demand for progress toward peace. This conciliatory gesture appears to be an attempt to persuade Washington against implementing secondary sanctions, particularly tariff hikes for countries that continue to purchase Russian energy. This potential action coincides with the imminent threat of tariff increases for India and China if a ceasefire agreement is not secured.

 Mexico and Canada Team Up: The two North American nations are exploring deeper trade integration to reduce their economic dependence on the United States. Their leaders have agreed to develop a joint strategy aimed at aligning supply chains and fostering collaboration in AI development. This initiative reflects a broader global reassessment of economic strategies, as Washington signals its retreat from the role of global importer of last resort.

 AI Boom: Siemens, the German industrial giant specializing in gas turbines and power grid equipment, reported that its order backlog has surged to a record high, driven by soaring electricity demand from data centers. This sharp increase reflects a wave of facility upgrades as companies worldwide modernize infrastructure to support expanding data center capacity. Notably, the AI boom appears to be insulating certain sectors from tariff concerns, as businesses increasingly view advanced technology investments as essential for future competitiveness.

 Investment Grade Surge: US companies have issued more debt in the first half of this year than in any comparable period since 2020, when the Federal Reserve aggressively cut rates to address the pandemic. This surge in corporate borrowing comes as growing optimism about recent trade deals has helped ease global economic uncertainty. Notably, much of this new issuance has skewed toward shorter maturities. Although demand may soften in the coming months, credit spreads are expected to stay relatively tight.

 Poland Infighting: Newly inaugurated Polish President Karol Nawrocki has indicated that he will slow down judicial reform efforts. This stance contrasts with the conditions set by the European Union regarding the rule of law that Poland must meet to unblock earmarked funds. His position is likely to create friction with the EU, and it highlights a broader trend of growing influence for right-wing political figures, particularly in Eastern Europe.

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