Institute Alert

• On August 25, President Trump said he will dismiss Federal Reserve (Fed) Governor Lisa Cook over allegations of mortgage fraud, but Gov. Cook replied that she will make a case to keep her seat.
• The Federal Reserve Act of 1913 gives the president authority to remove a governor for cause, but in this case the process does not appear clear-cut. Until now, no president has ever removed a Fed governor, and what constitutes sufficient cause may extend the legal process, possibly to the Supreme Court.
• The initial response across markets was muted. Long-term U.S. Treasury yields were slightly higher, while U.S. equity prices and the U.S. dollar ticked lower by small fractions of a percent.

• We believe the subdued market response is a nod towards a potentially extended legal battle.
• Nevertheless, the dispute likely signals the potential for larger financial market movements to come.
• If the president succeeds in removing Gov. Cook, we expect that he may secure a four-to-three majority of governors whose policy ideas align with his, and this has potential implications.
• What’s more, the Fed’s Board of Governors approves the selection of regional Reserve Bank presidents by the directors at each regional bank.
• These Reserve Bank presidents also participate in creating monetary policy, and so the final approval of Reserve Bank presidents could be another way for a majority of governors potentially to influence policy.
• Specifically, a majority of the governors might guide policy towards greater deregulation and much lower policy interest rates (and possibly higher future inflation) than the current Fed leadership has proposed.
• We already see room for long-term U.S. Treasury yields to rise ahead of the Treasury’s upcoming issuance of new long-term debt. If inflation expectations also become more variable, long-term yields could also become more volatile, an unfavorable combination for long-term investors.

• We believe that surprises – either from policy or from economic data – could trigger episodic periods of volatility, especially as the economy slows.
• We favor extending tactical positioning in areas that we believe should balance opportunity against short-term volatility risk. We illustrate this principle with our current guidance, summarized in the next section.

In fixed income, we expect to see diminishing return opportunities in short-term securities as the Fed resumes its rate cutting cycle. Meanwhile, we also foresee potential risks to long-maturity fixed income returns, as discussed above. At this time, we prefer intermediate-term (3-7 year maturities) fixed income securities to lock in higher yields than short-term securities will offer and with less return volatility than long-dated maturities.

Volatility in long-term rates also may raise long-term debt financing costs at a time when the economy is slowing, and while households and businesses are still adjusting to tariff impacts. Even as the S&P 500 Index makes new all-time highs, investors may want to trim equity allocations to position portfolios ahead of the volatility we expect over the coming weeks and months.

To be clear, we still anticipate economic and earnings growth to accelerate as 2026 develops, but we believe now is a time to rebalance portfolios, and particularly to manage positions that may have become extended during the rally in large-cap equities since April 8. On August 5, we introduced new guidance to rebalance portfolios from overweight risk to neutral. (For complete details, please see “Adjusting portfolio guidance and allocations”.) Our changes downgraded our Commodities rating from favorable to neutral. In equities, we trimmed gains in U.S. Large Cap Equities—while maintaining a favorable rating—and downgraded U.S. Small Cap Equities from neutral to unfavorable. We favor reallocating from equities and commodities into U.S. Intermediate Term Taxable Fixed Income.

The goal of rebalancing is to reduce exposure where prices have become the most extended and to recycle the proceeds into potentially better values. In this way, rebalancing seeks to reduce near-term risk and to look for new potential opportunities as markets enter a likely volatile period. One way to trim large-cap exposures but still keep an overweight is to follow our sector guidance. Among the S&P 500 Index sectors, we have reduced artificial intelligence (AI) exposure by downgrading Communication Services from favorable to neutral while keeping the Information Technology sector at a favorable rating. We also upgraded the Financials sector to anticipate lower short-term interest rates and associated bank deposit costs.

Forecasts and targets are based on certain assumptions and on 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. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility.

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. 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.

An index is unmanaged and not available for direct investment.

S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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