Plus, the long-term yield picture, retail resilience and trends supporting market gains.
As expected, the Federal Reserve cut interest rates by a quarter-point this week and their “dot plot” of projections of future interest rates predicts two more rate cuts this year. The current federal funds rate range is now 4% to 4.25%. The weekly average for a 30-year fixed-rate mortgage loan is around 6.25%, which is down from 7% earlier this year. The prime rate, which is the underlying benchmark interest rate that drives borrowing costs on home equity loans, auto loans and credit cards, is now 7.25%. But consumer borrowing rates remain quite high compared to the last decade, with home equity lines still above 8% nationally, auto loans for new cards trending at 7% and credit card interest rates above 20%.
While the Fed acknowledges that downside risks to employment have worsened, its policymakers are also continuing to juggle their dual mandate to support stable prices and maximum employment—inflation will just not cooperate. Fed Chairman Jerome Powell cited “a shift in the balance of risks” toward unemployment and noted moderating economic activity. He also observed that tariffs have pushed up the price of some goods. He said in his press conference he still thinks tariffs will have a one-time effect on prices, but added, “we can’t assume that.” In fact, according to their published projections, the Fed doesn’t expect inflation to reach its 2% goal until 2028.
Given those dynamics, the market is turning its focus to the risks of a steepening yield curve, meaning longer-term yields remain much higher than short-term ones. That’s tough on consumers and business owners as most borrowing costs key off intermediate-term interest rates and not the fed funds target rate. In fact, economists and Wall Street prognosticators are only predicting a decline in the 10-year Treasury note’s yield to 3.8% from its current more than 4% level, given high inflation, policy uncertainty and rising debt levels. This means there may not be much relief coming in consumer borrowing rates, a fact clearly frustrating President Trump and his team.
While financial markets had a muted reaction to the initial news of an interest-rate cut, markets have drifted higher into the end of the week. It does remain an open question whether investors continue to focus on the potential for rate cuts to juice growth, or the downbeat conditions that prompted the Fed to act. That will depend on inflation and how the economy and corporate earnings respond to rate cuts.
In other news of the week, the retail sales report for August showed solid growth of 5% year-over-year, marking the strongest pace of spending in four months. Back-to-school shopping and car and gasoline sales were the biggest drivers of that strong showing. Therefore, despite mounting concerns of a cooling labor market, the U.S. consumer continues to prove resilient, reinforcing the notion that while some policy easing may be justified in an effort to lower rates closer to neutral, this is hardly an ailing economy in need of dramatic policy support.
Other noteworthy developments this week included China’s request that companies not buy chips from Nvidia. Beijing has accused Nvidia of violating the country’s anti-monopoly laws. Meanwhile, Trump is in talks with President Xi Jinping today to finalize an agreement that will allow the popular video-sharing app TikTok to continue operating in the U.S. following legislation that technically banned the app on Jan. 19, 2025, unless parent company ByteDance sells a majority stake to non-Chinese owners.
Markets continue to trend at record highs, bulled up thanks to continued AI euphoria, Nvidia’s announcement of a $5 billion investment in Intel stock and collaboration to jointly develop data center and PC products, as well as resilient corporate earnings guidance being issued all around.
We’re also observing a notable uptick in the small-cap Russell 2000 index; these gains are in part due to anticipation of and reaction to the Fed’s interest-rate cut. The index is on pace for a gain of over 12% for the quarter. Smaller companies are often more rate sensitive, and the Russell has heavy exposure to regional banks, which tend to do better in a low-rate environment. For some time now, small-cap stocks have languished by comparison to larger U.S. companies that have dominated returns and investor demand, but for the moment we are seeing the appetite for risk extend down to these smaller companies, which is a sign of broader optimism in the stock market.
However, make no mistake that the trend of big-tech dominance at the top of the market continues. Over the last month going into Thursday, Magnificent Seven stocks were collectively up 10.5%, the S&P 500 index was up 3.7% and the Equal-Weighted S&P 500 index (which allocates to all 500 members equally rather than by market capitalization) was up only 0.7%. Will market breadth broaden into year-end? We can only hope, as it would be a welcome development to reinforce the value of diversification and reduce overall market risk to investors uneasy about sustained narrow market leadership.
Written by a human.