With the calendar flipping from August to September, kids heading back to school, and the feeling of fall in the air, many investors’ attention has also shifted from earnings to the Federal Reserve. Here, too, we have seen a change. Federal Reserve Chairman Jerome Powell’s recent speech at Jackson Hole seems to have all but solidified a cut at the upcoming meeting. Yet, from our perspective, investors need to be well aware of the tug of war brewing between inflationary pressures, fiscal concerns, and the economic environment. How this ultimately shakes out is likely to determine the course of rate cuts from here.

Let’s start with Jackson Hole, where the market clearly interpreted Powell as having been more dovish than had been expected. Right upfront, there was an acknowledgment that “the balance of risks appears to be shifting.” A nuanced discussion of both labor markets and inflation followed this. The key points came later in the speech, though:

“In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside – a challenging situation. When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate. Our policy rate is now 100 basis points closer to neutral than it was a year ago, and the stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance. Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.”

We can argue about just how restrictive the policy stance is, but what matters today is the Fed’s interpretation, not ours. Thus, it seems as though we should expect the first cut (since December 2024) later this month. The key question for investors, though, is what comes after that.

It’s clear that the Administration would prefer to see rates lower. For one, lower rates mean lower interest costs. It’s also true that lower rates could help to unlock parts of the economy that have been stuck in the mud for some time now. The most obvious example is housing, but lower rates would also help to ease the strain on small businesses that rely on bank lending as the lifeblood of their operations. From the market’s perspective, lower rates would also help to justify the current market multiple. Yet, the Administration is not in charge of monetary policy. There is certainly a case to be made that economic conditions are not nearly as rosy as equities would have you believe. Labor markets have been showing cracks, and there is no doubt that domestic demand has been slowing for the better part of a year. Thus, there is an economic case in favor of resuming the rate-cutting cycle.

It’s also true that there are very real reasons for concern on the other side of the Fed’s mandate: Inflation. We are already seeing an inflation rate in excess of the 2% target. There are clear risks – many of which were cited explicitly by Powell in his speech – to the upside from here. Leading indicators suggest that inflation rates may be pushing higher from here, and that’s being reflected in breakeven rates above those seen over much of the last decade, especially before Covid.

In the coming months, the Fed will likely have to make a clear choice about the importance of containing rising inflationary pressures or relieving some of the stress being felt in the economy due to the elevated level of interest rates. How this shakes out will be dependent upon factors ranging from incoming data to the potential choice between both sides of the Federal Reserve’s dual mandate. We have been adamant in our Perspective Newsletters that one of our high conviction views is that we expect volatility to be a feature of markets, and we’d reinforce that view in light of the dynamic discussed above.

As an experienced manager with a time-tested process, we feel well prepared for such an environment. We continue to believe that these challenging times require active management to strike the right balance between risk and reward consistently.

Our Perspective

We continue to find opportunities within our core portfolios to deploy our time-tested investment strategies. We believe that these uncertain times, characterized by change, call for an active approach to seeking out attractive opportunities while also managing risk in investment portfolios.

We have been cognizant of the downside risks to the US economy for some time now. While the US economy has been on a softening trajectory, growth has remained incredibly resilient due in large part to the massive fiscal transfers undertaken in the months and years following the pandemic and elevated household net worth. With the added uncertainty from US trade policy, we see an increase in downside risks. Market expectations have been for a continuation of the strong economic growth we have seen over the last several years, and we believe this may be overly optimistic.

To be clear, this does not mean we are calling for meaningful economic weakness; rather, expectations look elevated relative to reality. With the Federal Reserve having paused its cutting cycle, it remains to be seen how the economy will respond to a prolonged period of elevated rates and uncertainty. Given the varied risks we see in the market today, we are placing an emphasis on risk management.

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?

Indicates change Indicates no change

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.