Following a nine month pause, the Federal Reserve resumed its rate-cutting cycle, lowering the Federal Funds Rate by another 25 basis points in September. In doing so, Jerome Powell acknowledged the upside risks to inflation, but also discussed at length the risks facing the labor market. From our perspective, there are real questions about the Federal Reserve's ability to meaningfully lower rates and provide relief to rate-sensitive parts of the economy today.

As a starting point, the bond market is currently pricing in four rate cuts by the middle of next year, with a high probability of two more this year in October and December. This projection is important, as four additional cuts over the course of the nine months would represent a fairly aggressive rate-cutting cycle in a non-recessionary environment. This, in turn, would ordinarily be expected to provide a degree of relief to rate-sensitive parts of the economy, such as housing and small businesses, which typically rely on bank lending as opposed to bond funding. This would be a welcome development, as these have been key areas of weakness for some time now.

The question, though, is twofold. First, is such a cutting cycle warranted given the current backdrop? And second, would such a cutting cycle result in the long end of the curve coming down and providing relief?

Let's consider the starting point today. Growth in the US remains resilient, with consumption and non-residential investment acting as the key pillars of support. Consumption has largely been a factor of continued spending strength from the higher end of the income spectrum. Combined, the top two income quartiles account for more than 60% of consumption, so a continued rise in household net worth has been supportive. Absent a significant pickup in layoffs, which does not appear imminent, or a meaningful decline in asset prices, consumption is expected to remain on solid footing.

Moving on to non-residential investment, this has been almost entirely driven by the investment boom in the AI space. Looking at forward guidance, there is little reason to expect an imminent slowdown here, either. While this is subject to change, we must work with the information we have and probability weight the potential outcomes; right now, that means assuming a continuation of current spending trends as the base case for the economy. On top of these factors, the fiscal impulse from the One Big Beautiful Bill becomes more stimulative in the coming months.

Given this backdrop, how necessary are another 100 basis points of cuts? There is no doubt that the housing market would welcome lower mortgage rates, and frankly, it probably needs it (though this doesn't address the affordability issue). Similarly, small businesses would welcome lower interest rates and the impact on lending costs.

But getting to our second question, what do we think the impact of a lower Federal Funds Rate would ultimately be? In an environment where growth in aggregate is already at healthy levels, and inflation is already running above target with risks tilted to the upside, there is a real risk that cuts could push rates on the long end higher. To that end, rates across the curve have risen since the decision to resume the cutting cycle.

Our Perspective

The bottom line is that we continue to be in an uncertain and fairly unique environment. The path forward is unclear, and the outcome difficult to predict. As an experienced manager with a time-tested investment process across asset classes, we feel well prepared for any environment. We continue to believe that these uncertain times require active management in order to consistently strike the right balance between risk and reward.

Our View

Economic Cycle		The US economy has remained resilient despite the aggressive hiking cycle we saw from the Federal Reserve. However, growth is slowing from above-trend levels. Can the US consumer continue to remain resilient? Could policy change be disruptive, or might factors such as deregulation support investment?
Stock Market		The US stock market continues to trade near all-time highs. Earnings expectations reflect a rosy outlook. With the Fed looking more cautious on its rate cutting cycle, can earnings growth support higher prices in the potential absence of multiple expansion?
Bond Market		Risks to the economy and inflation look balanced. While elevated levels of inflation and resilient growth could push yields meaningfully higher, a sudden slowdown in growth could also see cuts priced back into the market and yields fall from their current levels. Corporate spreads remain near their lows.
Important Issues on the Radar		Trade Policy: The new Administration has rolled out an aggressive trade policy at a time when the US economy is already slowing. It’s unclear how the US and its trading partners will navigate this ordeal, and we see the policy at the very least as having injected a great deal of uncertainty into the global economy.
		AI: Booming investment in semiconductors and AI infrastructure has been a feature of markets for years now. Will the release of lower-cost models lead to a reduction in investment or could increased efficiency super-charge these efforts? How may AI begin to have a real impact on businesses and the economy?

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Sources: FactSet. Federal Reserve.

All investments contain risk and may lose value. This material contains the opinions of Manning & Napier, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.