William Blair macro analyst Richard de Chazal dissects July’s economic surprises—from noisy GDP data and sticky inflation to the disruptive rise of stablecoins and a renewed case for small- and midcap stocks.
Podcast Transcript
00:22
Chris T
Hi everybody. Today is August 1st, 2025. After a dynamic month of economic surprises, policy recalibration and digital disruption, you know, we're back to unpack what it all means.
From the Fed's wait-and-see stance, a stronger than expected GDP print, the rise of stablecoins and a renewed case for smidcaps, there's a lot to cover.
So joining me to break it all down is William Blair macro analyst Richard de Chazal. Richard, welcome back. Good to have you with us again.
00:50
Richard D
Nice to be back Chris.
00:52
Chris T
So let's start with the GDP report. The second quarter came in pretty hot. 3% annualized growth. Well above expectations. What's behind the you know, the strength and how should we think about it in the context of the broader economy?
01:09
Richard D
Unfortunately, I don't think we should be too comfortable with that figure because I think the, you know, the headline number was great. I think the expectation was something like 2.4%. So that was pretty good. But I think we have to remember that Q1’s GDP was really weak. So that came in at -0.5%. And the reason for that was a big surge in imports in the first quarter.
And if you go back to your high school economics classes, GDP stands for gross domestic product. So it's a measure of domestic economic activity. And if you're importing more, that gets classified as a negative. So exports minus imports, that's your net trade contribution to GDP. And because of the threats from tariffs early on in the first quarter, you had companies and households that were pulling forward a lot of demand.
They were stocking up on inventories to get ahead of those price increases. And the import component of GDP in that first quarter subtracted almost five percentage points from GDP in the quarter. And now we moved to the second quarter. And companies and households, they've already stocked up. So they're not importing much anymore. So that import component then collapses.
And you know, that actually flipped back and added 5.2 percentage points to GDP. So that's reason why I mean, it's we're getting a lot of noise in the economic data. And I think the best way to cut through all of that is to look at what is, you know, has rapidly become probably be the best core measure of GDP. Which Chair Powell keeps talking about, he was talking about that on Wednesday, and that's this, real final sales to private domestic purchasers. Or you know what he sort of dubbed RFD. And that's a measure the economist Jason Furman came up with when he was on the Council of Economic Advisers. And what it basically does is say, okay, what's really the demand from households and from the business sector?
So let’s strip out inflation. Let's strip out the impact from inventories, government spending and trade and see what the demand is really like. And that change in private sector demand only increased by 1.2% in the quarter. So it's not terrible, but it's not particularly great either. And what we've actually seen is, is that's continued to come down for the last three quarters.
So it is indicative of actual, a moderation, in Japan. So I think, you know, what we're seeing is a situation where growth is okay, but with all the certainty, companies and households are still a little bit wary about making any, any big spending decisions.
04:19
Chris T
Got it. So inflation also cooled a bit. This is a recent headline, headline PCE at 2%, core was at 2.6%. But with tariffs at play and you know inventories adjusting, how sticky do you think inflation is from here?
04:35
Richard D
I think it’s going to be a little bit sticky for a while. So you know we just got some new PCE data yesterday actually for June. And that actually showed a little bit of a tick up. So it went from 2.4% to 2.6 on the headline. And then the core rate was unchanged from May at 2.8%. But there had been some upwards revisions too.
And then if you actually look at the six-month annualized change. So sort of the momentum there, that's pushed up to 3.2%. So prices have actually started to tick a little bit higher. You know, if we break that down I think goods prices have been a strong contributor there. That's, you know, no surprise because of the tariff, we've all been kind of expecting that.
But then the other side is the services side. And I think what we've been expecting there is that those services prices would start to come down more and offset those price increases on the on the good side. And that's, that's where you're seeing the stickiness still. So super core which excludes housing and energy. That's still stuck at 3.2%.
So again it's still mostly a tariff thing. I think you know, that that will fade. We're not quite there yet. So that, you know, inflation rate is still high enough above the Fed's target that it's a little bit uncomfortable. Maybe we've started to see inflationary expectations. So the market based ones on swaps. So one year inflation expectations there ticked up a little bit through the month of July.
So I think you know the message there. And I think the message of Fed would be taking is is not quite done yet on inflation. It's you know, we've made a lot of progress. Few bumps in the road potentially still from tariffs. But not entirely out of the woods just yet.
06:36
Chris T
The Fed has held up rates steady again. But we saw two dissenters calling for cuts. So what's your read on the Fed's posture right now? And how close are we to a pivot?
06:46
Richard D
Yeah. So we had we had two dissenters. That was the governors Waller and Bowman. As usual, that was kind of telegraphed ahead of time. But that's the first time we've had two dissenters since 1993. So that's significant. You know, usually the Fed chair does a pretty good job of, of wrangling the the troops ahead of the Federal Open Market Committee (FOMC) meeting and kind of wants everybody to look like they're on board with the decision.
So, you know, could be that some of Waller's decision to dissent is related to his desire to be the next Fed chair, which he has said, you know, he definitely wants the job. And he was on Bloomberg a couple of weeks ago basically saying that. So, you know, maybe it's possible that he wants to look good for President Trump, who wants to presumably appoint a more dovish person when Powell leaves and so could be some truth in that.
But I think it's also true that the supporting evidence that Waller has given in his speech recently to, you know, has, you know, there's good justification for lowering rates and he basically talked about two areas. I think the first is he believes that tariffs are a bit of a red herring on the inflation side. So basically, they are a consumption tax, they are a one off price increase. And he doesn't think, you know, they're going to cause any inflationary issues over the medium term. So not, you know, we shouldn't be keeping rates high because of that.
But then the second thing is that he thinks that cracks are beginning to show in the labor market. He's worried that the employment growth is being overstated. And, you know, because of faulty seasonal adjustment and that kind of thing, we're going to get big downward revision to the data we're actually seeing over the last year. When those revisions do come out later on. So the employment growth we're seeing is, is not as strong as it would be suggested. And actually, we got a hint of that in the just released employment report today where we saw some pretty significant downward revisions to, both May and June's growth rates.
And, and I think the second thing, Waller is being worried about has been the structure of where those gains are coming from in employment. So a lot of it's been in the government sector, and it's actually looking to private sector employment growth that's been relatively weak as well. So that's you know, his reasons for dissent.
I actually, you know, I wasn't I'm probably still in the Powell camp, from, from what he was talking about this this past week, where there's still, there's still a little bit of room for wait and see.
I think if you look at the Fed's dual mandate, the main problem still seems to be inflation is above, where it where it should be, whereas employment is kind of at full employment. I mean, it is a little bit of a balancing act. And I think the Fed is also worried that you know, what happened after the Covid, they really discovered that people really, really hate, inflation and they blame the Fed for that.
So I think, you know, he wants to say, listen, if we can just hang on a few more months, get a better idea of what kind of inflation impact the tariffs are going to have, and we don't want to be seen to be lowering rates just ahead of what could be at least a little upwards blip in, in inflation.
So you know he's sort of let's wait and see a little bit. And then I think, you know more broadly is the market screaming out for cuts today? And I don't think so. I mean if you look at we're seeing another little bubble perhaps in the meme stocks, these new sort of bunch of, I don't know what they call them, the donuts or. That's not indicative of a market that's liquidity starved.
If you look at high yield credit spreads they're super tight. Again, not indicative of, super tight, you know, area there or any stress. I think the only area where you're seeing, you know, rates are too high is the housing market. Those, again, are tied to ten year yields, not to the Fed funds. So the Fed has a little bit less control over that. That's more like macroeconomic conditions which drive that. And government financing. As part of that. So I think Powell is right that the rates are moderately restrictive. They are going to come down. My guess is now they come down in September. And that's more sort of a as an insurance rate cut rather than anything else. I don't think it's because a recession is imminent. They're more sort of moving rates from what is moderately restrictive back to sort of a more a more neutral setting.
12:00
Chris T
Let's shift the conversation to digital finance. You know, stablecoins have been making waves, especially with the GENIUS Act gaining traction. What's the real disruption here? And how might this reshape the financial system?
12:14
Richard D
I think I think these are super, super interesting. I think any time you get any sort of big new innovation in finance, you know, that does bring some risks to it. You know, the market picks up on this new area. It sort of runs with it, gets too excited about it. Something bad kind of happens. Then the Fed has to mop it up. And then the regulators come in after and perhaps do what they should have done before this whole thing started in the first place. So I think the GENIUS Act is, is maybe a way to try and get ahead of that, that they see that these things are growing and need to get on top of that. Maybe it's not perfect, but certainly it's a start of some regulation.
But I think, you know, as you say, what's important here is that this could be very disruptive to the traditional banking system. And I think what these coins offer is a faster, more secure, more anonymous and a cheaper way of transferring and handling money. So it's kind of like me just, you know, taking 50 bucks out of my wallet and handling it or handing it personally, to you, there is there's no middleman involved there.
There's no one sort of saying, Chris, you know, Richard, you give me the money and then I'll give it to Chris. But I'm going to take a little bit of commission on that. Maybe it's going to take me three days to hand over that money to you, because they're kind of going to hang on to it for a bit.
So I think that's. And then and then I'm going to record everything, you know, that we're doing here. And so this kind of eliminates all that. And I think for, for the unbanked or even like many emerging markets, this this is a total godsend. These stablecoins, you know, it's potentially life changing stuff.
I think what you know, what's important is that these are not like Bitcoin. These are backed 1 to 1, with a safe asset like treasuries, gold or, you know, dollars. And I think not all of them are those same. So there are some super stable ones, entirely risk free ones.
And you know, you can go down the spectrum and, and so there been there has to be regulation on who's issuing them. You know, where are they being issued from. There could be runs on the bank. So they're, they're, they're, they're there are financial stability issues here I guess, just like you're more traditional bank. So there needs to be a regulatory wrap around them. But I think they are a threat to the traditional banking system in the sense that, you know, you could get people who are looking at these and say, well, what's the point of holding deposits in a bank if you know, these are going to be faster, more secure, cheaper and easier to work with and then holding money in a bank?
So I think the banks are justifiably concerned that you may get start to get this kind of migration away from of their deposit bases into stablecoins. And I think that's why, you know, a couple of the largest banks in the US are saying, hey, wait a minute. We can't afford not to be in this. So we are we're starting to issue our, our own coins here.
And I think what the stablecoin does though too is it bans the coin issuers from paying, paying interest rates on those deposits that you're holding. So that gives the traditional banks a little bit more room, you know, a little bit more cover here. But I think it's super interesting. And I think it is only going to going to grow.
16:17
Chris T
So one other thing about stablecoins, you wrote that stablecoins could even impact monetary policy. Can you expand on that a bit? How might their growth affect the Fed's ability to manage short term rates?
16:30
Richard D
I mean, I think one thing the GENIUS Act does though is it bans creation by the Fed of its own digital currency. So a CBDC. Because I think the problem there is it could actually be too good. You know, that's one of these things like, you know, this, the, the never ending light bulb.
16:51
Chris T
The LED’s? Yeah
16:52
Richard D
Well no, the actual old light bulb that with the filament that never burned out, I think is still burning.
16:58
Chris T
Oh, is that right? I didn't even know that. Interesting.
17:00
Richard D
Yeah. They, they can make much better light bulbs then they make. But then they have no one to produce them because there's no replacement demand for these.
17:08
Chris T
How do you make money on that? Right.
17:09
Richard DI think that's the risk almost with, central bank, digital currencies is that these are ultra safe. And why would you, you know. Yeah. There's no zero risk if the Fed's backing it up with its own, you know.
17:25
Chris T
Sure. Why invest in anything else? Yeah, yeah.
17:28
Richard D
So, I think there's a point where the Fed has to make, you know, if they were going to make them, they would have to make them good. But not too good.
So anyways, I think that the ECB is struggling with that problem at the moment. But the Fed the, the GENIUS Act has just outright said, well we're not we're not going to do it.
But I think why the Trump administration likes these and is and you know, why they could affect monetary policies is kind of in in two ways is the first, as we sort of mentioned earlier, is these coins are backed one for one with a safe asset.
And that's most often Treasury bills. So as the demand for the stablecoins increases, so does the demand for those T-bills. So how much of that is actually net new demand and not just demand moving from another sort of big asset to whatever? It's hard to say. And I think it would depend on foreign take up of some of these, stablecoins, but definitely some. And I think that has the potential to put downward pressure on the short end of the yield curve, where there's more demand and what might have otherwise been there. So almost a kind of form of QE taking place.
So that could potentially distort yields at that end. And I think then the Fed would have to come in, you know, do something to sort of offset that.
But the second reason is, is that while the administration likes them a lot, is that about 99.9% of these coins are dollar denominated. So, you know, if you are encouraging their use, you're also encouraging continued dollar dominance. So you're opening up, you know, more users to or more use cases for more dollar transactions. So again, you know that pushes back on theories of the dollar losing its reserve currency status.
So the dollar can still go down within this context. But I think it it's reassuring about any worries about dollar losing its reserve currency, which I don't think is is going to happen anytime soon.
19:45
Chris T
So before we wrap, let's talk smidcaps. We've brought this up in the recent past, but you recently restated the case for them. What's changed, would you say, in the macro backdrop that makes this segment more attractive right now?
19:58
Richard D
Yeah. So as you say, I've restated this because unfortunately I, you know, found them attractive for a while now and they haven't really performed all that well or as well as, as well as would, would be hoped. But I think there is, is room for, for outperformance going forward. And at least in that report, I sort of outline six main reasons.
I think the first is diversification. I think we've been in this world where we had a negative correlation of stocks to bonds, and now we have a positive correlation there. But when we were in that sort of old world of negative correlation, investors could run very highly concentrated portfolios. Knowing that they could be offset with, you know, 40% in, in bonds.
But I think with that positive correlation now between stocks and bonds, investors are going to have to start doing their own sort of self-insurance, de-risking portfolios in other ways. And I think that means through greater diversification, so less highly concentrated portfolios. And I think that opens the door to more, smaller and mid-cap type stocks. So I think that's interesting.
Second reason is valuations, Professor Damodaran, he likes to talk about the narrative and the numbers. And typically you need both for stocks to work. And while the numbers could be really good, so a good balance sheet, good earnings you also need a narrative to wrap around them. And I think that's one of the things that the smidcap space has been has been missing.
Whereas conversely, the large caps in some cases, you could argue that it's actually being too much narrative and not enough not enough numbers. So I think, you know, if you're if you're looking at the smids, definitely the numbers are there. So they look very attractive on, different valuation metrics like PE, price to book, price to sales, all of these relative to large look, you know, historically very, very attractive.
And I also think that's signaling that a lot of bad news is already being priced into the. So there's a margin of safety there, in the sense that, you know, if the market goes down, it seems likely that these will likely go down less, over, you know, over that.
And third, I think, you know, there's a case to be made that lower interest rates will help here to, again, rates moderately restrictive. We can argue, you know, exactly how much rates are going to come down. But I do think rates are going to come down over the next over the next year. And I think smidcaps are more sensitive to those rate changes on the short end of the yield curve than the long end, which are, more relevant to the large cap.
So I think, you know, the large caps tend to have the luxury of being able to borrow in capital markets, sort of wherever they want and borrow ten years, 20 years corporate, corporate debt, they can tap, tap international capital markets, you know, so they have they have more access to financing. So they're less sensitive relative to the mid and small about what the Fed is doing at the short end domestically.
So if the Fed lowers rates these guys feel it more. They're the ones who can really only borrow at the short end through bank loans through short term paper. So again, they're feeling it more. And I think what we also see is that, let's give these, mid-caps, they're, they're also very sensitive to the yields curves.
And, and again, you know, the yield curve is steepening. Banks are typically more prepared to land. They get a better loan spread there. It's usually indicative of a of a stronger economy. And I think what we're seeing at the moment is that, you know, a much steeper yield curve. And what we haven't seen yet is a typical start up outperformance as the smidcaps start to perform better, with that steeper yield curve.
So I think, I think that could be, could be helpful for I would say that that, capital market activity has been warming up again. So more IPOs, more M&A. That's typically synonymous with, less risk aversion and more risk taking, which, again, would be better for the for the smids.
President Trump's policies, I think could also be more helpful. The smids tend to be more domestically orientated than the sort of the big international, large caps. So, for example, if we were to see more in the way of deregulation, regulation has been a huge moat for the larger cap stocks. So, if we start to see some deregulation, taking place, then again, that would be sort of be cutting red tape back and more helpful for these, smaller and mid-cap stocks.
And the last thing I say, as, as maybe is more of a potential I'm not entirely sure of this, but it feels like it should help is the impact from AI and maybe the blockchain. So maybe, you know, I think one of the advantages a large cap companies have had recently over the small is, is being that they could sort of hire these football fields full of data coders and all that kind of stuff. So they had they had the data and they had the coders. And I think today with AI, ChatGPT, at least that helps level the playing field with the number of coders that are needed.
So maybe they don't have the data still, but that helps level them out, with, with actually finding workers. So again, I think net net, that could be a slight positive in in their favor.
So let's see, I think it's an exciting, exciting place to look at.
26:13
Chris T
Well, Richard, that's all the time we have for today. But you know, as always looking forward to bringing this convo back up next month. Thank you for taking the time to be with us and we'll talk soon.