Market Is Underestimating a September Rate Cut

We get a fresh look at the jobs JOLTS (I focus on the QUIT rate, as it is almost a “crowd sourced” measure of sentiment in the labor force). We get ADP, which has been weak, but the market has chosen to ignore it. And finally, we get the NFP data, where the headline has surpassed expectations the past three months, while the underlying details haven’t fully supported that.

One theory, which I believe in, is that the tariffs and uncertainty have hit small- to mid-sized businesses hardest and the data from these companies takes more time to show up in the hard data.

It is also true that while uncertainty has slowed hiring, the inability to hire, post COVID, is so fresh in the minds of employers that they are slow to let people go.

I'm expecting some mild equity weakness and bond strength as the jobs data hits this week.

I cannot imagine the FOMC doing much other than signaling, again, that they are watching inflation (and stating that tariffs take time to work there way into the system) and jobs (which have seen slight weakening, but are still strong). They should put September on the table (though I would have set up to cut this month).

It will be curious to see how the Q&A goes as I expect many of the questions, which Chair Jerome Powell will be unlikely to answer, other than purely factually, will be less about monetary policy and the state of the economy and more about relationship between the Fed and the Trump administration.

The market is pricing in 65% chance of a cut in September and 1.7 cuts on the year. I think that is a bit low, but I'm not sure this meeting (or the data) will shift it enough to be bullish for equities.

Unless Powell surprises to the dovish side, or the economic data is really weak, then the FOMC should be a non-event.

Which leaves us with tariffs. It seems quite clear that 15% is the new norm for major trading counterparties, other than China. The deals have all come with statements about purchasing U.S. good or investing in the U.S. It is unclear how much is new spending rather than spending already occurring (Europe is buying U.S. energy products, for example). It is also unclear on what form the investments will take.

Markets have responded “calmly” to the slew of announcements over the weekend (an EU deal and another likely extension with China).

But it is too early to take victory laps on tariffs and the trade deals.

Tariffs will take time to hit the economy. Only as new inventory is brought into the country will the tariffs be paid. It looks like the U.S. generated $28 billion the past two months in tariffs and excise taxes (up from $8 billion to $9.5 billion per month for the past several years). The additional $20 billion per month should increase as more goods are imported at higher tariff rates. Only over time will we see what the cumulative effect of tariffs does to prices and/or corporate profit margins.

I believe that the equity markets are not holding up because of tariffs or trade deals, but primarily because "national production for national security" is real:

• Treasury Secretary Scott Bessant used almost those exact words last week in a Bloomberg TV interview
• President Trump pledged to support AI, and the energy needed to power AI and data centers through deregulation
• It is finally dawning on people how important the accelerated depreciation component of the new tax law could be, to fuel economic growth, with the government providing some “nudges” in the right direction
• As we mentioned in the past, while the MP deal may not be a template (the Department of Defense only has so much money to allocate) we should see more government directed and supported investment across industries (tech, pharma, etc.) while pushing forward in the extraction, processing and refining of rare earths and critical minerals

I continue to like being overweight in the areas that benefit the most from this, including utilities or energy production companies poised to benefit.

I am learning that I need, in my own mind at least, to stop equating energy with oil and gas, and to start equating energy with electricity. I find that helps me focus on the right areas to invest, though very little in the space is “cheap” by any definition.

I continue to watch small caps, as they have underperformed, but since I believe the largest, best capitalized companies can deal with the tariffs and uncertainty best, I’d hold off on them, except to the extent individual companies or sectors benefit from the "national production for national security" theme.

I'm slightly cautious in equities, but with a bias to the themes already listed. The dollar has started to rebound potentially, which won’t help U.S. stocks.

I'm mildly bullish on bonds here and bery bullish on municipal bonds, especially longer dated ones, where the difference between tax free and taxable bond yields is at levels rarely seen.