Weekly Newsletter: September 29, 2025
“Been dazed and confused for so long…” Following the Fed meeting, this Led Zeppelin tune may be playing through the corridors of the Fed offices. Fed speakers fanned out around the United States last week to explain their views on the economy, employment, and inflation. Taken together, it is little wonder that there is no cohesive view and, as a result, a plan for monetary policy. The latest inflation gauge, the Personal Consumption Expenditures (PCE) index, showed inflation still sticky around 3%. Officials are convinced that tariffs may have a role in some of that inflation, but those impacts should dissipate over time. Unfortunately, President Trump, just this week, announced additional tariffs on a variety of goods. This “messing around” with tariffs makes it nearly impossible to say with any confidence that price increases from tariffs will be around for longer than many expect. Static employment with little hiring and firing should keep employment near historic lows. Friday’s employment report will likely show modest job growth, wage gains, and little movement in overall unemployment. Swiping another song title, “The Kids (consumer) Are Alright”. Overall consumer spending remains at a brisk pace and above most economists’ expectations. Taken together, it will be hard to make the case that the Fed should cut rates again this year. That does not prevent the Fed from cutting rates anyway.
Much of the discussion from various Fed governors centers around the amorphous “neutral rate” or the interest rate that is neither too easy nor too tight, but just right. The problem with trying to define the neutral rate is that it is not a fixed rate that is stable over time. It is unobservable, and the Fed uses a variety of models to try to determine that rate in real time. Today, it is estimated to be 3.7%, while the current Fed Funds rate is between 4-4.25%. Meaning to many on the Fed, interest rates are too high and should move toward that 3.7% figure. This also assumes that the Fed is correct that inflation trends toward their 2% target over the next two years. Funny thing, for the last four years, they have been projecting inflation to reach their 2% target over the next two years. We are still waiting. Moving from the ethereal to the practical, there seems to be plenty of money floating around the economy and financial markets, indicating a lack of stress or worries about monetary policy being too tight. As is normally the case, this upcoming employment report will be THE most important economic data point since…the last employment report.
Yields have ticked up since the Fed cut rates two weeks ago, following the same pattern as a year ago, the last time the Fed cut rates. Many market observers look to the yield on the 2-year treasury as a proxy for where the Fed funds rate should be. At roughly 3.7%, it does match up with the neutral rate described above. That 2-year yield is pretty much unchanged from a year ago, before it rose by 75bp into the end of 2024. Basic trend following indicators would argue that rates should be declining into this year-end, but the inflation picture can change that view rapidly. Without a deterioration in economic conditions, it would be hard to see rates much below where they are today.
The quarter ends on Tuesday, and in keeping with the recent history of the market, another winning quarter. As has been the case with many quarters over the past five years, technology has been the standout performer. Surprisingly, though, small stocks kept pace with the SP500, as expectations are high that the Fed will continue to cut rates, making it easier for small companies to borrow and/or refinance existing debt. Technology, specifically companies around AI, is the main driver of both prices and earnings of the SP500. It has been estimated that nearly 80% of the growth in earnings of the SP500 has been derived from the AI-related companies. Some analysts are beginning to warn investors that much of that earnings growth is coming from selling/buying products from each other. What happens when the frenetic pace ultimately slows down? It sounds very similar to some of the arrangements made in the late 1990s by Cisco to facilitate the purchase of Cisco’s products. It is argued that the companies today are stronger financially. However, the circular web discussion is making a comeback. The focus on AI is creating opportunities for investment in other parts of the market, like small stocks and international markets. Both fared well last quarter and could be a sign of things to come.
Watch the employment report on Friday for clues on the strength or weakness of the job market. Wage growth should help determine whether the consumer can continue spending through year-end.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.