The first week of September brought a cluster of important U.S. releases that confirmed an economy heading towards a significant slowdown or an outright recession.
The ISM manufacturing survey for August came in at 48.7, a sixth straight month in contraction. New orders finally returned to expansion at 51.4, the first positive reading in seven months, but production slipped to 47.8 and employment remained depressed at 43.8, while the prices index eased slightly to 63.7, still elevated. These numbers reveal a stagflationary environment in the U.S. manufacturing sector. Later in the week, the ISM services index showed greater resilience, rising to 52.0 from 50.1 in July. Business activity improved to 55.0 and new orders to 56.0, though the employment index stayed weak at 46.5. The two surveys together suggested a mild rebound in demand but a persistent weakness in hiring across both manufacturing and services. The consistent weakness of business sentiment is having a significant impact on the actual employment data.
Labour market data reinforced that message. The JOLTS report for July showed job openings flat at 7.2 million, hires at 5.3 million, and separations also at 5.3 million. Quits remained at 3.2 million and layoffs at 1.8 million, indicating a stagnant turnover environment. On Friday, the August employment report confirmed that job creation has slowed sharply, with payrolls up only 22,000. The unemployment rate rose to 4.3 percent, the highest since 2021, and manufacturing jobs fell by 12,000. Downward revisions to prior months included a negative print for June, the first monthly job loss since 2020. Challenger’s report of 86,000 announced job cuts in August, the highest August total since 2020, added further evidence that the labour market is losing momentum quite fast and we might see an outright contraction in employment by the end of the year with a further rise in the unemployment rate.
The labour data had immediate policy consequences. Fed funds futures moved to fully price a 25 basis point cut in September, with rising odds of a 50 basis point move. One-year forward contracts are now implying a rate of about 2.9 percent, dropping below the 3 percent threshold for the first time in this cycle. This repricing has been reinforced by a visible shift in tone within the FOMC. Christopher Waller and Michelle Bowman dissented at the July meeting, already calling for immediate cuts. More recently, Austan Goolsbee signalled that easing may be appropriate if inflation remains contained, while Raphael Bostic highlighted risks from a softening labour market. These dovish turns have emerged against a backdrop of political pressure. President Trump has sought to tilt the balance of the Board, moving to dismiss Governor Lisa Cook on allegations of mortgage fraud. Cook has denied the charges and challenged the decision in court, remaining legally in office as the case proceeds. At the same time, Treasury Secretary Scott Bessent has amplified criticism of the central bank, arguing in a Wall Street Journal essay that the Fed has suffered from “mission creep” and calling for its authority over bank supervision to be curtailed. The pressure from both the White House and Treasury is reshaping the policy environment, where dovish positions inside the Fed are increasingly difficult to separate from political influence.
Under that scenario we expect the yield curve to steepen and the dollar to go through renewed downward pressures given the fact that the differentials in interest rates between the U.S. and the rest of the G7 will continue to compress over the near future, unless the Euro zone goes through another political storm given the coming vote on the French budget and the possibility of the fall of the government, a subject we covered in our last week’s post.
On the fiscal side, Treasury Secretary Bessent has also been active in signalling interventions on housing. He has suggested that the administration may declare a national housing emergency this fall, with tariff exclusions on key construction materials such as steel, copper, aluminium, and lumber to ease building costs. These remarks come as housing affordability remains politically sensitive and are aligned with a broader fiscal strategy that couples tariff policy with targeted relief. The housing sector is facing a problem of supply above all, given the fact that after the GFC housing completions have consistently fallen short of the increase in household formation. The policy of the U.S. government should be geared towards supporting urban development, land allocation for housing, and tax credits for housing construction companies.
The recent rhetoric of the government, from taking a stake in Intel, to forcing massive local investments by the giant tech companies, to exerting political influence on the Federal Reserve, and now intervening in the housing sector, are all signs of the beginning of the era of fiscal dominance, in which the government plays a major role in steering and managing the overall economy. The U.S. is starting to look more like traditional European countries than a free market economy.
Trade policy remains in flux. Despite months of negotiations, no comprehensive deal has been reached with China. Instead, the United States extended its tariff truce by ninety days in August, keeping average tariffs around 30 percent on Chinese imports and 10 percent on U.S. exports through early November. A recent executive order slightly narrowed the scope of reciprocal tariffs, exempting certain bullion products, critical minerals, and pharmaceuticals, but the overall framework remains intact. The risk of escalation is high: if the truce lapses, tariffs could rise to as much as 145 percent on Chinese imports and 125 percent on U.S. exports. In parallel, export controls are tightening, with the Commerce Department revoking TSMC’s license exemption for shipments of advanced chip-making tools to China effective December 31. These measures underscore the persistence of U.S.–China trade and technology frictions, with little sign of resolution.
The average tariff rate on U.S. imports of goods reached 11 percent and is expected to rise to 18 percent by the end of the year. In previous posts, we outlined that for now the tariffs will cause a one-time increase in consumer prices of 5 to 5.5 percent. For now, with the underlying weakening conditions of the economy, we don’t see signs of a strong second-round effect. Tariffs are a tax, and like any other tax, they will hit household disposable income.
Japan
Japan has been experiencing a wave of political turbulence that is starting to reverberate through economic policy. Prime Minister Shigeru Ishiba, once a rising star, now faces serious challenges. In the July 2025 House of Councillors election, the ruling Liberal Democratic–Komeito coalition lost its majority in the upper house, compounding its earlier loss of majority in the lower house. For the first time in decades, the coalition no longer controls either chamber of Parliament. The result was a historic setback that has triggered increasing calls for Ishiba’s resignation. Opposition parties, including the Democratic Party for the People and the right-wing Sanseito, have capitalized on public dissatisfaction, especially around inflation, wage stagnation, and the fallout from the slush fund scandal. Approval ratings for Ishiba’s government have sunk to around 25 percent, from above 40% in 2023, putting his leadership squarely in jeopardy.
This instability is spilling over into economic planning. The national budget process, already under strain from record spending demands, is at risk of delay as political wrangling intensifies. That roils both fiscal and monetary policymaking: analysts point out that uncertainty around Ishiba’s survival and LDP unity may compel the Bank of Japan to adopt a more cautious stance on interest rate hikes. Government debt stands at over 220 percent of GDP, the highest ratio in the developed world. Rising social security and healthcare costs, combined with record spending requests for the 2026 budget, are pushing the fiscal burden even higher. Debt sustainability has long depended on the Bank of Japan’s willingness to suppress yields through asset purchases and yield curve control. With core inflation holding above the 2 percent target and the BOJ’s policy rate at 0.5 percent, the scope for further tightening is constrained by fiscal arithmetic: even small increases in yields can quickly translate into a much higher interest bill. Political uncertainty, coupled with the scale of issuance required to fund new spending, is forcing markets to question how long Japan can allow rates to go up to fight inflation without testing investor confidence.
Meanwhile, the Bank of Japan continues to navigate this storm. Though it maintained its policy rate at 0.5 percent in its last decision, Governor Kazuo Ueda signalled readiness to act if inflation dynamics warrant it. Meetings with Ishiba and public statements underscore the central bank’s cautious yet balanced posture amid heightened political risk and the heavy debt burden.
Regards,
Andre Chelhot, CFA
Editor
The Macro Anchor