Hawks Make Way for the Doves: Potential Shift in FOMC Sentiment

August marked another month of resilience for U.S. equities. The S&P 500 gained 1.9%, the Nasdaq advanced 1.6%, and the Dow Jones surged 3.2%, marking its best monthly performance of the year. Notably, the Russell 2000 small-cap index outperformed with a 7.1% gain, suggesting a broadening of market leadership after several months of mega-cap dominance. This increase in overall market breadth is generally positive for the overall economy because it shows that gains are being driven by a wider range of companies and sectors, signaling healthier underlying growth, stronger corporate fundamentals, and a more sustainable market rally rather than one concentrated in just a few large names.  As we move into the last months of the year, it is critical that we remain focused on the underlying fundamentals of not only the underlying stocks but also the global economy in general.

Earnings and Corporate Fundamentals

The underlying strength of corporate America continued to show. Over 80% of S&P 500 companies beat Q2 earnings expectations, well above historical averages. Technology and consumer discretionary sectors once again led the way, driven by robust demand for AI infrastructure, digital services, and resilient household spending. Meanwhile, cyclical and smaller-cap companies displayed improving breadth, albeit with mixed guidance as tariff and cost pressures weighed on margins. The continued uncertainty surrounding tariffs as well as other administration policies has led to price spikes in both directions, but we do believe that these price fluctuations may provide attractive entry points in an environment where valuations may be frothy at this time.

Labor Market and Inflation

August labor data showed a clear cooling trend. Non-farm payrolls added just 22,000 jobs, well below expectations of ~75,000, while the unemployment rate climbed to 4.3%, the highest since 2021. Job gains in health care and social assistance were offset by declines in manufacturing, government, and wholesale trade. This softness comes on the heels of downward revisions to prior months, reinforcing the message of a gradually weakening labor backdrop.

Inflation data showed progress but remained above the Fed’s long-term 2% target. Headline CPI eased to 2.7% YoY, while core PCE stayed near 2.6–2.8%, underscoring sticky but cooling price pressures. Together, softer jobs and moderating inflation increased the likelihood of a policy pivot.

Impact of Expected Fed Rate Cuts

The combination of a cooling labor market and moderating inflation has markets nearly fully pricing in a 25-bps rate cut at the September FOMC meeting, with expectations of further cuts through year-end. Here’s how this easing cycle may impact the economy and markets, with tangible examples for clients:

Equity Valuations and Sentiment

Lower interest rates raise the present value of future earnings, boosting valuations. For example, growth-oriented companies like Nvidia or Microsoft, whose valuations depend heavily on cash flows years into the future, would benefit disproportionately compared to a utility company with near-term, stable earnings. This dynamic explains why technology and growth sectors often rally most during easing cycles.

Fixed Income & Yield Curve

Bondholders benefit as yields fall, and bond prices rise. If the 2-year Treasury yield drops from 3.5% to 2.75%, an investor holding a bond paying 3.5% becomes much more attractive, driving its price higher. Intermediate-term bond funds such as VCIT (which we hold in portfolios) are positioned to capture both higher prices and stable income in this environment.

Borrowing Costs & Refinancing

Rate cuts lower borrowing costs for households and corporations. A homeowner with a 6.5% mortgage may be able to refinance into a 5.75% loan, saving hundreds of dollars per month. Corporations with large debt obligations—such as airlines or retailers—may also refinance at lower rates, reducing interest expenses and freeing up cash for investment or shareholder returns.

Consumer & Economic Activity

Cheaper credit supports consumer spending. If auto loan rates decline from 7% to 6%, a family financing a new car could save $30–$40 monthly. Similarly, businesses may move forward with expansion plans when financing costs fall, supporting jobs and growth. This effect could provide a near-term tailwind to sectors like housing, autos, and consumer discretionary goods.

Final Thoughts

August reinforced the market’s resilience amid a backdrop of cooling labor data and moderating inflation. While risks remain, from trade policy uncertainty to elevated equity valuations, the likely pivot toward rate cuts offers meaningful support to both equities and fixed income. Long-duration assets such as technology and growth equities stand to benefit most, while intermediate-duration bonds are positioned for price appreciation as yields drift lower. From an investment perspective, this underscores the importance of staying invested and balanced. Rate cuts will likely ease financial conditions, but volatility may continue to play a role as the Fed carefully navigates slowing growth and persistent inflation.

During periods of financial and economic uncertainty, it is important to remember that our primary goal is to provide you with Financial Peace of Mind while knowing that we are monitoring the situation and adjusting behind the scenes. We hope that you have a wonderful start to the fall season and look forward to seeing you again soon!