Not So Fast: Fed Easing, Debt Ceiling Jitters, and Stagflation Worries make the upcoming quarter one to watch
For many commentators the recent data seems to have reduced uncertainty and given the market a new narrative to hold onto. We remain a bit skeptical of an all-clear signal, at least as it concerns volatility. That doesn’t mean we are dogmatically bearish here calling for a major correction but that, as it usually does, the market overreacts to the news in the way it likes to lean. Today’s Consumer Price Index (CPI) aligned with forecasts, while yesterday’s weaker Producer Price Index (PPI) (-0.1% MoM) is fueling hopes for 50 bps Federal Reserve (Fed) cut in September, though Federal Funds Futures (FFF) price 25 bps, ~75 bps by YE. Strong productivity and tech earnings may be what is supporting elevated S&P valuations, but the 2-10 yield curve eased (to about 0.48% currently) indicating bonds believe in the stag part of the economic story more than inflation. Strong Treasury auctions have heartened bond investors, but it should not be ignored that long-end volatility persists. Tariff and debt ceiling risks still loom seemingly out of the national debate but softening labor alone may not be enough to fully justify aggressive cuts.
Macro, Fed, and Market Implications & Investment Focus
- Yield Curve Easing: The 2-10 spread had narrowed to about 41 bps on real growth fear in late July. After steepening to above 60 bps a few weeks ago the recent inflation data and fear of labor slowing, it has dropped to 0.52% despite the FFF forecasting significant easing into the end of the year. As a result, strategists are considering increasing long-end bets, but resilient economic data suggests that could be based on premature economic weakness assumptions as well as buying into a full Fed easing program.
- Debt Ceiling Concerns: Approaching $36.1T limit (supposed deadline in Sept 2025), Well publicized (and politicized) tariff court rulings are a fiscal wildcard, amplifying debt ceiling concerns. These talks are urgent; historically resolved, but renewed policy polarity makes it a key risk to watch, potentially spiking volatility.
- Inflation & Tariff Risks: Weaker PPI (-0.1%) eases pressure, but tariff pass-through fears could limit the Fed’s 150 bps easing by Dec 2026 to 100-125 bps; court rulings only add to the uncertainty.
- Contentious Fed Dynamics: September Federal Open Market Committee (FOMC) risks dissent (e.g., hawks like Waller); Powell’s presser may signal dovish (more easing) or hawkish (tariff and growth caution) cut, with Cboe Volatility Index (VIX) futures (19-20) into year end signaling volatility. While the Fed has always claimed to be apolitical, the debate around the issue certainly heightens focus and impact of their decisions this quarter.
- Sector & Strategy: Tech/AI, infrastructure industrials, utilities shine. Stock-picking small/mid-caps for growth in a bifurcated economy does present opportunity but understanding balance sheet dynamics is critical with Fed easing assumptions still a question mark. Hedged equity can balance upside participation with equity valuation, volatility, and tariff/debt ceiling related risks. Expect numerous economic datapoints in the next quarter as well as each Fed meeting to be live and possessing market moving potential.
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