Lower rates, new equity highs

RECAPPING LAST WEEK

U.S. equity indices gained ground after the Federal Reserve restarted the interest rate easing cycle, lowering its benchmark rate by 25 basis points to a 4.00% to 4.25% range. The Russell 2000 index jumped more than 2%, reaching a new record high for the first time since last November. The Nasdaq Composite index also rose more than 2% while the S&P500 added just over 1%. Technology led mixed performance in S&P500 sectors, boosted by news of Nvidia’s massive investment in Intel. U.S. Treasury yields ended the week flat at the short end and higher at the long end despite the Fed signaling two additional rate cuts for this year.

While Fed Chair Powell said that the softening labor market was now top of mind for the committee, the central bank’s statement acknowledged that inflation hasn’t just remained elevated but has moved up. Powell characterized the rate decision as a “risk-management cut” in reaction to weakening jobs data, but stubborn inflation underscores the Fed’s challenges in carrying out its dual mandate. In its Summary of Economic Projections, the FOMC raised its GDP growth and inflation forecasts while lowering the projected unemployment rate, seemingly in conflict with easing monetary policy. The updated “dot plots” suggested only one more rate cut in 2026 to a range of 3.25% to 3.50%, which is higher than market expectations of a sub-3% fed funds rate.

Turning to economic data, U.S. retail sales rose 0.6% in August, rounding out a resilient summer of consumer spending. Jobless claims fell back to 231,000, likely confirming that the prior week’s large jump was an anomaly. Regional manufacturing surveys from the northeast revealed widely diverging sentiment. Activity in New York State declined more than expected on a large drop in new orders, while the Philly Fed survey spiked into positive territory as shipments surged. In housing news, new construction plunged last month while building permits fell to the lowest level in more than five years. Mortgage rates fell last week to 11-month lows, but persistent U.S. budgetary and inflation pressures still clouded the outlook for homebuyers seeking more affordable conditions.

Overseas, the Bank of England kept rates unchanged at 4% after last month’s CPI reading held steady at 3.8%–the highest among developed economies. UK labor market data has held up well enough to not raise recession concerns. The BOE also announced plans to slow the pace of reducing its stockpile of government bonds to minimize the impact on the volatile gilt markets. The Bank of Canada cut rates by 25 basis points to 2.5% but gave little indication of next steps even as economic data showed signs of increasing stress. Japan’s central bank revealed a more hawkish turn despite leaving rates unchanged at 0.5%. Two of the nine board members voted for a quarter-point hike while the Bank of Japan also decided to start selling its riskier ETF holdings sooner than expected. Core CPI readings have eased recently but Japan’s headline inflation has remained well above the 2% target for more than three years. Finally, China’s industrial production and retail sales figures for August came in lower than estimates, while unemployment inched up to a six-month high of 5.3%.


THE WEEK AHEAD

The U.S. dollar rallied late last week and volatility was mostly subdued, boosted by the Fed’s optimistic economic outlook and a muddled interest rate forecast beyond this year. Whether or not those trends continue could be influenced by several events on this week’s calendar. First, there are a plethora of appearances by FOMC members to be scrutinized.

Secondly, Friday’s PCE price index release is expected to show that inflation pressures are continuing to rise, albeit modestly. And third, flash PMI readings in the U.S. and elsewhere will provide a sense of how the manufacturing and services sectors are holding up as the end of the third quarter approaches. Other releases on the U.S. calendar include new and existing home sales, the final estimate of Q2 GDP, durable goods orders, and the goods trade balance for last month. Micron Technology reports earnings on Tuesday followed by Costco on Thursday.

On the international side, Japan’s inflation updates and minutes from last week’s BOJ meeting are the notable releases along with the previously mentioned flash PMI readings. Investors will continue to monitor U.S.-China trade negotiations and progress on the government funding bill that passed the U.S. House on Friday but faces an uphill battle in the Senate with the September 30 deadline looming.

(Schwab)