Updates

The Year Begins with Elevated Geopolitical Risk as Markets Confront High Expectations…

• The year 2026 opened with an immediate geopolitical shock. Over the weekend, U.S. special forces captured former Venezuelan president Nicolás Maduro, an event that injected fresh volatility into global markets. Energy equities reacted swiftly with oil and gas shares moving higher on concerns over regional instability and potential supply disruptions. Companies with historical exposure to Venezuela and Latin America, including Chevron and ConocoPhillips, outperformed as investors repriced geopolitical risk into the energy complex.

• Looking back, 2025 delivered strong results across most major asset classes. International developed equities led performance, with several markets posting gains in excess of 25%. U.S. equities also finished the year solidly higher, driven largely by sustained enthusiasm surrounding artificial intelligence and related capital spending, leaving major indices up in the mid-teens depending on the benchmark. Fixed income provided meaningful diversification with upper single-digit returns, while cash remained unusually competitive as it offered yields north of 3%. The result was a broadly favorable environment in which both risk assets and defensive allocations contributed to returns.

• As markets progress through early 2026, sentiment can best be described as cautiously optimistic. Equity indices are trading near record highs while the federal funds rate sits at its lowest level in more than three years. Inflation appears modestly contained with recent readings below a 3% annual pace with unemployment near historic lows. However, downside risks are becoming more apparent. Economic growth has grown increasingly reliant on higher-income consumers and an AI-driven investment cycle that now represents a meaningful share of national capital expenditures. In contrast, middle-income households continue to feel pressure from elevated living costs as lower-income consumers face mounting financial strain leaving the current economic expansion more vulnerable to even modest policy missteps or demand shocks.

• This week’s labor-market data will be an important test of economic momentum. Wednesday’s JOLTS and ADP reports should offer early insight into hiring trends, but Friday’s Bureau of Labor Statistics employment report will carry the most weight. As the first non-delayed release following the recent shutdown, it will be closely watched. Consensus expectations call for the unemployment rate to rise to 4.7%, alongside a modest December job gain of roughly 57,000—figures that would reinforce concerns that labor conditions are gradually cooling as 2026 begins.

AI-Driven Volatility, Softening Labor Trends, and a More Dovish Fed Path…

• Investor attention pivoted last week from the Federal government’s reopening to the sudden fragility of the AI-driven stock trade. The core group of mega-cap beneficiaries—Amazon, Nvidia, Microsoft, Meta, Oracle, Google and Tesla—has broadly traded lower this month with Oracle down more than 20% and Google the sole advancer as it has risen almost 25% recently. Because these companies have contributed nearly half of the S&P 500’s year-to-date advance, the reversal has magnified market volatility and highlighted the degree of concentration risk embedded in the market. With AI-related capital expenditures responsible for roughly half of the year’s first-half GDP growth, a meaningful decline in these stocks could translate into real economic softness. Some analysts estimate that a 20%–30% equity decline could trim 1 to 1.5 percentage points from GDP.

• The delayed September employment report added another layer of uncertainty to investors. Hiring improved to 119,000 jobs – the strongest monthly gain since April – but significant downward revisions revealed that job creation from May through August totaled only 55,000 positions, materially weaker than initially reported. Unemployment edged up to 4.4%, reinforcing the sense that underlying labor-market momentum continues to cool. For policymakers, the landscape is increasingly uncomfortable: job growth is still positive but no longer strong enough to offset the concerns about inflation remaining above the Federal Reserve’s target.

• Attention now turns to the final Federal Open Market Committee meeting of the year where investors remain divided on whether a final 25-basis-point rate cut will be made. Expectations have swung sharply day to day as markets have digested softer labor data, elevated inflation, and rising equity volatility. Late-week reports that National Economic Council Director Kevin Hassett is the leading candidate to become the next Federal Reserve Chair added a new wrinkle to the macro-economic landscape. Hassett is viewed as being politically aligned with further easing to support economic momentum, prompting Treasury yields to fall meaningfully. The 10-year Treasury moved below 4% for the first time in months as markets priced in the possibility of a more dovish policy path under his potential leadership.                                         

Markets Rebound as Government Looks Likely to Reopen…

• Equities began the week higher despite ending the prior one on a softer note, supported by optimism that a bipartisan deal to reopen the government was imminent. Late Sunday, eight Democratic senators joined Republicans in approving a short-term funding measure, marking the likely end of the prolonged shutdown that had disrupted data releases and heightened uncertainty. While the agreement will restore basic government operations, economists expect it will take several weeks before the backlog of delayed reports is cleared, and concerns over the accuracy of federal data could linger into 2026. As a result, investors are increasingly turning to private-sector reports to assess real-time economic conditions.

• Recent private employment data has been inconsistent, reflecting a murky labor picture. ADP reported that U.S. companies added 42,000 private-sector jobs last month—a modest rebound after two months of declines while Challenger, Gray & Christmas reported a sharp rise in announced layoffs with 153,000 cuts in October alone. Year-to-date job cut announcements now exceed 1.1 million, roughly 65% higher than in the same period last year. The divergence highlights an economy in transition: job creation continues, but employers are increasingly cautious amid slowing demand and elevated financing costs.

• Consumers remain under visible strain. The University of Michigan’s November sentiment index fell to 50.3 from 53.6 in October, among the lowest readings in the survey’s history. Experts state that lower-income consumers are the most frustrated, while higher-income households are feeling less optimistic than they were at the beginning of the year. The Wall Street Journal reported earlier this year that top 10% of earners accounted for almost 50% of all consumption, underscoring how disproportionately the economy depends on affluent households to sustain demand.

• Looking at the almost completed 4^th quarter earnings season, corporate profits have generally exceeded expectations with more than 80% of S&P 500 companies reporting better-than-forecast third-quarter profits. However, equity market reactions have been muted, implying that solid results were already priced into valuations. Within the technology sector, enthusiasm for artificial intelligence investments has moderated as investors have begun to question stretched valuations and escalating capital expenditures. The recent pullback in major tech names signals a more discerning market—one increasingly focused on balance-sheet strength, profitability, and sustainable growth rather than unchecked optimism about AI-driven expansion.

Fed continues its rate easing even as elevated inflation persists while data clarity fades…

• Today’s 25-basis-point rate by the Federal Reserve Open Market Committee (FOMC) continued its broader interest rate easing cycle. Given Chair Powell’s post meeting comments, interest rate futures declined appreciably from an 85% probability to a 69% likelihood of another quarter-point rate cut in December. The Fed chair emphasized a more data dependent strategy moving forward as progress on inflation has stalled although appreciable concerns remain regarding the weakened labor market. At this stage, the central bank’s bias is inclined towards continued easing policy into early 2026, though much less certain than mere days ago.

• The Fed’s dual mandate—maximum employment and price stability—has rarely been under greater strain. Labor market indicators show slowing job creation, rising part-time employment, and waning worker confidence. By lowering rates, policymakers aim to stabilize employment and sustain consumer spending, though doing so risks reigniting inflation. With core CPI still running at 3%, well above the Fed’s 2% goal, each additional rate cut could deepen concern that policy is turning prematurely accommodative.

• We do not agree with the Fed’s more recent rate reductions as inflation has been hovering at the 3% level for almost 2 years. If price increases remain at these levels for the indefinite future, we are extremely concerned that inflation expectation will become anchored at these levels, or higher. By accommodating labor markets today, future labor markets could be severely hurt as the Fed is forced to pursue an extremely hawkish policy to regain control of inflation and return it to the 2% target.

• Complicating matters further, the ongoing government shutdown has severely limited visibility into economic activity. The Department of Labor’s delayed release of the Consumer Price Index (CPI) – necessary for calculating next year’s Social Security cost-of-living adjustment – showed headline and core inflation both rising 3.0% year-over-year, modestly below expectations but still uncomfortably high. The resulting 2.8% COLA for 2026 underscores the persistence of underlying price pressures. With few economic reports available, investors are left to interpret fragmentary signals. Treasury yields eased slightly, and equity markets advanced on the CPI announcement, reflecting optimism that policy will remain supportive into next year. Whether that optimism holds will depend on whether inflation continues to moderate – or forces the Fed to pause an easing cycle barely underway.

Fed Cuts Rates as Labor Market Risks Mount…

• Last week, the Federal Reserve announced its first rate cut of the year, lowering the overnight federal funds rate by 25 basis points. Chair Jerome Powell emphasized in his post-meeting remarks that the decision was not a response to political pressure but rather a reflection of growing concerns about the labor market. In a notable shift of language, Powell no longer described labor conditions as “solid,” warning instead that the “downside risk is now a reality.” This acknowledgement underscores the Fed’s evolving focus from inflation management towards protecting employment and growth.

• While the committee’s vote showed broad agreement, it also revealed tensions lurking beneath the surface. Eleven of the twelve voting members supported the quarter-point cut, while newly appointed Governor Stephen Miran dissented as he advocated for a more aggressive 50-basis-point cut. The Fed’s updated dot plot further highlighted divisions: ten of the nineteen participants expect at least two additional cuts before year-end, while seven foresee no further easing. Such dispersion signals uncertainty about how deeply labor-market weakness may extend and whether inflation pressures will allow more flexibility.

• Markets will be closely watching the release of the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) Index, which is released this Friday. Consensus estimates call for headline inflation of 2.7% year-over-year and 0.3% month-over-month, a slight moderation from the prior reading. Core PCE is expected to clock in at 2.9% annual growth with a 0.2% monthly gain. These figures, if realized, would confirm that inflation is stabilizing but still running appreciably above the Fed’s long-term target.

• Despite the renewed emphasis on labor risks, inflation remains a substantial concern. Atlanta Fed President Raphael Bostic cautioned that tariff-related cost pressures, while thus far absorbed by companies, may eventually be passed through to consumers. If so, the economy could face a slower, more prolonged period of moderate inflation rather than an abrupt surge in prices. Taken together, the Fed’s actions reflect an effort to balance softening labor momentum against persistent, though contained, inflation risks.

Fed Poised for Rate Cut Amid Labor Weakness and Political Pressure…

• The FOMC meets next week with expectations firmly set on a rate cut. Markets see a 25-basis point move as the most likely case, but weak labor data has raised the probability of a 50-point cut. Morgan Stanley recently updated its outlook, now projecting the fed funds rate to fall into the 2.75%–3.0% range by late 2026—about 150 basis points lower than today. The focus has shifted from if cuts are coming to how quickly and how deep.

• Labor market momentum appears to be fading as the August payrolls added just 22,000 jobs, far below consensus of 75,000. Revisions showed June turning negative (–13,000) and only a small upward adjustment for July. Year-to-date job creation of 598,000 is the weakest pace outside the pandemic’s 2020 since 2009. Notably, most gains are concentrated in health care, a traditionally resilient sector, masking broader weakness. This slowdown gives the Fed both the data cover and urgency to ease policy.

• Meanwhile increasing political pressure raises credibility risks for the central bank. The Trump administration has escalated its attacks on current Fed policy, openly pushing for easier conditions and signaling interest in reshaping Fed leadership. History offers a cautionary tale: in the 1970s, Arthur Burns’ Fed bowed to political demands, fueling double-digit inflation. Paul Volcker later had to push overnight rates above 19% to restore credibility. Investors should be alerted to rising risk premiums if Fed independence is seen as compromised.

• Markets are now adjusting for a lower-for-longer rate path. Forward curves and strategist forecasts now embed a multi-year easing cycle with significant declines expected by 2026. While this supports equity multiples and risk assets in the near term, the policy trade-off is delicate. A slower labor market justifies cuts, but political overhang and central bank credibility concerns could drive volatility. Investors should watch the Fed’s messaging as closely as the size of next week’s rate cut.

Markets brace for likely September rate cut as the Fed chair recasts economic risks…

• The Federal Reserve’s annual Jackson Hole summit concluded with a notable shift in tone from Chair Powell and his colleagues. Powell emphasized that “the balance of risks appears to be shifting,” suggesting that concerns are no longer concentrated solely on inflation. Instead, policymakers are increasingly attentive to the risk of labor market deterioration, warning that such weakness can emerge quickly in the form of higher layoffs and rising unemployment. This marks an important change in the Fed’s policy narrative, signaling that employment stability is becoming as crucial to the central bank’s deliberations as is inflation.
• The labor market has indeed softened in recent months. July’s employment report showed below-trend job creation, and downward revisions to the May and June data effectively erasing much of the earlier strength, leaving net hiring flat over the summer. Economists have characterized this dynamic as a “No Hire, No Fire” economy – where job creation stalls but employers, facing tight labor conditions in prior years, continue to hoard talent aggressively. This stagnation, however, may be an early warning sign that economic momentum is fading more broadly.

• Against this backdrop, two Fed governors at the most recent FOMC policy meeting argued for a rate cut. The latest labor data has provided Chair Powell and other cautious members with the justification to consider such an action more seriously. Markets responded swiftly to Powell’s comments with investors now treating a September rate cut as all but guaranteed. Equity indices advanced on the expectation of easier monetary policy while Treasury yields moved lower in anticipation of a lower rate environment.

• Looking ahead, the July reading of the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) Index, will be released later this week. Consensus expectations call for headline inflation at an annual rate of 2.6% with a 0.2% month-over-month increase, and slightly below last month’s pace. Core inflation is projected to be 2.9% year-over-year with a 0.3% monthly increase.

Markets Weigh Mixed Inflation Data Amid Trade and Policy Shifts…

• The latest Consumer Price Index (CPI) report — the most widely followed gauge of U.S. inflation — showed a mixed picture for July. Headline inflation came in at 2.7% year-over-year, slightly better than the 2.8% economists expected. Core CPI, which excludes volatile food and energy prices, rose 3.1%, exactly in line with forecasts. While these numbers follow June’s Personal Consumption Expenditures (PCE) report, which also showed a mild uptick, the overall tone suggests consumers are not yet feeling a pinch — though economists caution that recently imposed tariffs could feed into prices over time.

• On trade, President Trump this week extended the U.S.-China “truce” for another three months, setting a new deadline of November 10th. After the most recent negotiations in July, U.S. officials felt confident an additional extension was possible. China, for its part, has paused certain export restrictions, signaling optimism on both sides. Investors will be watching closely to see if this goodwill translates into concrete agreements that could reduce uncertainty for global supply chains and business investment.

• In policy news, Federal Reserve Governor Adriana D. Kugler will unexpectedly stepped down on August 8th, months ahead of her scheduled term end. President Trump has tapped Stephen Miran, current Chair of the Council of Economic Advisors, as a temporary replacement while a permanent nominee is sought.

• Separately, the president dismissed head of the Bureau of Labor Statistics on August 1st, claiming the need for more accurate initial jobs data after the latest report included sizable revisions. As no data was given in support of the Administration’s claims, analysts were deeply troubled by this move as the U.S. government has historically been the global gold standard for having the best, and least political, economic data.

The Pressure for Rate Cuts is Increasing…

• Despite war raging in the Middle East and Europe, domestic protests across the country, and volatile tariff policies, American markets continue to move higher. The S & P 500 and the Russell 1000 Value indices are now positive on the year with Treasuries continuing to trade in a tight range.

• Clearly, the markets are in a “risk on” mode as they have largely ignored the intensifying war between Iran and Israel. While it appears to be unlikely, the chance of an expansion of the current conflict cannot be totally ignored.

• The Federal Open Market Committee (FOMC), the group that determines the Fed’s overnight lending rate, will begin its fourth meeting of the year this week. The market, along with most investors, believes the committee will leave rates unchanged. Currently, the Street is still pricing in one, if not two, quarter point cuts before the end of the year. With most recent economic data being relatively benign, the chorus is getting louder for the Fed to cut rates with recent inflation reports coming at, or below, expectations.

• Meanwhile, employment numbers have largely held steady. Consumer sentiment has declined appreciably year to date largely due to the changing tariff environment although it showed a modest increase in the latest reading. Adding to the pressure to cut rate are the persistent and vocal demands from the Administration for interest rates to come down. However, the evolving tariff and trade landscape has made Chairman Powell and other FOMC members more hawkish, which could prolong the amount of time before more cuts occur.

• It is expected that President Trump will not reappoint Jerome Powell for another term as Federal Chair. Currently, projections suggest that Treasury Secretary Bessent is likely to be nominated instead. As Powell’s term nears its end, there are concerns that Chair Powell may become a lame duck with little influence and authority in shaping policy decisions.

Tariff uncertainty continues to have economic ripple effects…

• Tariff headlines continue to dominate the news and is strongly influencing not only the US economy but that of the world. Last week, the Bureau of Economic Analysis confirmed the drop in GDP for the first quarter of 2025 to an annualized decline of 0.2%, slightly better than the -0.3% expected. The contraction was due to a sharp increase in imports as many businesses brought forward overseas purchases in an attempt to avoid some of the new pending tariffs. 

• One of the more important data points found in the latest GDP report was that consumer spending grew at a very modest rate of 1.2% annually. This is the lowest increase in three years, down significantly from the 4.0% growth rate in Q4 2024. The diminished consumer buying was a poor economic sign as the American shopper represents more than two thirds of the nation’s economic activity.

• The PCE index, i.e., the Fed’s preferred inflation gauge, was reported last week and showed an annual growth rate of 2.1%, beating the 2.2% expectations. Core PCE reported a growth rate of 2.5%, also beating expectations of 2.6%. Both numbers continue a drift down towards the Fed’s goal of 2%. Whether this will be sustained in the face of the Administration’s erratic tariff policy is yet to be seen. As a result, the markets continue to price in at least two rate cuts before the year-end.

• The Fed Chair and his team have been reluctant to reduce rates so far this year for fear of stagflation, largely due to economic uncertainty created by the Administration’s new tariff stance. Policy setting members so far have agreed that the high economic uncertainty coupled with the increased risk of higher unemployment and inflation warrants a wait and see approach. In a recent meeting with President Trump, Fed Chair Powell reportedly maintained his stance that central bankers will make interest rate decisions based solely upon “careful, objective and non-political analysis.”  How the potential disagreement between the Fed and the new Administration is resolved remains to be seen.