Market Commentary

• Federal Reserve (Fed) Chair Jay Powell has been adamant in recent public comments that the Fed is uncertain as to the inflationary effects of tariffs that are ultimately implemented.
• The last thing the Fed wants to do is lower interest rates and then have inflation creep higher, forcing the U.S. central bank to backtrack.

If you are at all paying attention to the news, especially the financial news, you are well aware that a whole host of people are debating whether the Fed should be cutting interest rates. Some would argue the Fed is behind the curve and should have already lowered rates while others have been of the opinion that the Fed should hold pat. Investors are clearly focused on what our central bankers might choose to do over the course of the next few Fed meetings. Just as a point of reference, the Fed holds eight monetary-policy meetings each calendar year. Most of the time, but not always, any change to the fed funds (overnight) target rate range that occurs is announced to the public on the last day of the meeting (usually a Wednesday and at 2 p.m. ET). There are three meetings left in 2025: September, October, and December.

Fed Chair Jay Powell has been adamant in recent public comments that the Fed is uncertain as to the inflationary effects of tariffs that are ultimately implemented. The last thing the Fed wants to do is lower interest rates and then have inflation creep higher due to tariffs, or any other reason, forcing the U.S. central bank to backtrack and end up increasing rates in an attempt to help bring down price pressures. Also consider that recent reports have shown that inflation is creeping higher. For example, our projection calls for a 3.2% Consumer Price Index (CPI) in 2025, above where the Fed wants to see it and noticeably higher than the 2.7% year-over-year increase through June. A good part of that call for higher inflation is due to tariffs.

But the Fed is also focused on the labor market, and last week’s July employment report certainly caught the eyes of every voting member. Historically, a 4.2% unemployment rate is well below the average rate of 5.9% going back to January 1961 per Bloomberg data. That is an average taken through good and bad economic times as well as high and low inflationary periods. We continue to believe the labor market will weaken further in coming months and quarters. But it would be tough for many strategists to call the labor market “weak” given the low unemployment rate that Chair Powell has recently described as “at or close to full employment.”

Given that, the market is putting a high probability on the Fed cutting next month based on fed funds futures contracts. As of the time of this writing, fed fund futures are reflecting an 98% probability of a September cut. We think that probability is too high. We have one cut penciled in over the balance of this year, but it would be hard for the Fed to cut in September if inflation is slowly moving higher and the unemployment rate is still low.

The uncertainty surrounding tariffs, inflation, and a slowing economy pushes us toward high-quality equities. We suggest that investors trim small-cap allocations and lighten up on the fairly valued Energy and Communication Services sectors. We favor moving those funds into the Financials (most favorable), Tech, and Utilities sectors. 

Forecasts, estimates, and projections are not guaranteed and are based on certain assumptions and views of market and economic conditions which are subject to change.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the communication services sector may also be affected by rapid technology changes; pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

Consumer Price Index (CPI) produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.

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