by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment begins by examining the escalating risk of a direct conflict between the West and Russia over Ukraine. We then analyze the latest GDP figures and explain our cautiously optimistic outlook for the US economy. Additional topics include the looming threat of a government shutdown, the lowball offer by the US for TikTok, and a recent breach of security on devices used by federal government officials. We also provide a summary of key recent economic indicators from the US and around the world.

War in Europe? European diplomats have privately delivered a stark warning to Moscow, suggesting that NATO could potentially shoot down Russian aircraft that violate the alliance’s airspace. This direct threat marks a significant escalation following a series of recent incursions by Russian military planes into the territory of several European countries. These actions are viewed as a deliberate test of NATO’s response. The warning is the closest hint yet that the conflict in Ukraine could directly spill over into the rest of Europe.

• The warning appears to reflect Washington’s hawkish stance toward Russia. This is based on President Trump signaling earlier this week that Europe should down Russian aircraft entering its airspace, as well as comments from Ukrainian President Zelenskyy that he had Washington’s backing to strike Russian energy infrastructure and arms factories with US-supplied long-range weaponry.
• Moscow appears to be taking these threats seriously. Russian Foreign Minister Sergey Lavrov recently stated that Russia may already be at war with its Western rivals. This sentiment was underscored by an incident a day after the warning, when the US scrambled military jets to intercept Russian planes detected off the coast of Alaska, highlighting Russia’s continued ability to project power toward US territory.

• These heightened tensions coincide with the US’s increase of its weapons exports to Europe to help Ukraine defend against the Russian invasion. While European purchases of US weapons have slowed from a peak of nearly 35% of American exports, they remain well above pre-pandemic levels and still account for nearly a quarter of the total. This growing European reliance on American armaments further underscores the risk of deeper US involvement should a broader war break out.
• While a full-scale conflict is not seen as inevitable, the current geopolitical climate suggests that tensions between the West and Russia are arguably at their highest point since the Cold War. This is a precarious moment, and if NATO or the United States were to follow through on threats of retaliation against Russia, it could potentially trigger a broader conflict involving other nations.

GDP Report: The US economy demonstrated surprising resilience in the second quarter, with growth revised up to a 3.8% annualized rate from a prior estimate of 3.3%. Final Sales to Private Domestic Purchasers, a key indicator of underlying economic strength that excludes volatile inventories, government spending, and net exports, was also revised upward from 1.9% to 2.9%. This suggests that core domestic demand was more robust than initially thought. Nevertheless, a closer look at the report’s components reveals a more nuanced situation.

• This upward GDP revision was primarily fueled by a significant surge in consumer spending, which was revised from 1.9% to 2.5% and accounted for the bulk of the growth. The strength in consumption was driven by higher-than-initially-estimated spending on services, particularly in transportation, financial services, and insurance. An additional boost came from nonresidential business investment, led by spending on AI.
• While growth was better than expected, it continues to reflect an economy adjusting to a new normal. The primary contributor to GDP was net exports, driven by a significant drop in imports. This decline occurred because many firms and households had front-loaded their foreign purchases by stockpiling goods in the first quarter, which had caused growth to contract during that period. The subsequent pullback in spending in the second quarter artificially boosted net exports.
• Looking ahead to the second half of the year, we expect growth to remain relatively stable. Despite growing concerns about the job market, households have sustained their spending. One area we are monitoring closely is trade, as a continued decline in imports is artificially supporting growth. Historically, such a trend has indicated that households are becoming more conservative. While we do not anticipate an economic contraction in the third quarter, the outlook for the fourth quarter remains uncertain.

Government Shutdown: The White House is dramatically escalating the government shutdown standoff by requesting that federal agencies plan for mass layoffs targeting employees in programs that would lapse in funding and do not fit the president’s priorities. This move of issuing permanent Reduction-in-Force notices instead of temporary furloughs is widely viewed as an attempt to force the opposition to accept a short-term funding deal before the October 1 deadline. The budget impasse persists as the president seeks to follow through on reigning in spending.

Bye-Bye Fed Funds? Dallas Fed President Lorie Logan is proposing to shift the Fed’s primary rate target from the federal funds rate to a repo rate. This reflects the dramatic shrinkage of the traditional interbank market, with institutions preferring the more robust repo market. Targeting the repo rate could make the Fed more effective in directly controlling current financial conditions. However, the move carries an inherent risk of market disruptions or unintended consequences within the interbank lending system.

TikTok Deal: The White House announced that it has valued the forced sale of the popular video-sharing app’s US operations at $14 billion — significantly below the original $40 billion estimate. While officials stated the final price will be determined by investors, the lower valuation highlights the US government’s effort to minimize the cost of acquiring the platform. This move follows a law that mandates the app’s divestiture within 120 days to avoid its shutdown, citing national security concerns.

More Tariffs: President Trump has now targeted tariffs on pharmaceuticals, heavy trucks, and furniture to pressure producers to manufacture more of the goods in the United States. Patented pharmaceutical products could potentially face tariffs as high as 100%. This decision is part of a broader effort to encourage firms to reshore operations. The president has also announced that pharmaceutical companies that begin construction of manufacturing facilities in the US will be shielded from these new tariffs.

Government Hack: A breach has compromised firewall devices used by US federal government officials. While the full scope of the impact is unclear, the threat is considered widespread. The attacks have exploited a backdoor in Cisco devices. This campaign appears to be part of a broader international effort, and although there is no evidence of state actor involvement, investigators believe it is unlikely that the hackers are acting alone.

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