The Fed’s Cautious Pivot: What It Means for Markets?
The Federal Reserve’s decision to cut rates by 25 basis points at its September meeting—bringing the target federal funds rate to a range of 4.00% to 4.25%—marks its first move in nine months. More telling than the cut itself is the tone accompanying it. Labor market activity has softened since the last FOMC meeting, prompting the Fed to resume its easing cycle. However, the broader economy isn’t weak enough to warrant aggressive action. Instead, the Fed is signaling a cautious, measured approach—balancing the risks of a slowing labor market against persistent inflation uncertainty.
Chair Jerome Powell’s remarks underscored this delicate balancing act. While acknowledging rising downside risks to labor market, he emphasized the unpredictability of tariff passthroughs and the broader inflation outlook. Labor supply shifts, data measurement challenges, and policy uncertainty further complicate the picture. Given these dynamics, the Fed is treading carefully. We expect two more 25 basis point cuts this year, followed by further easing in 2026. This should amount to a gentle, supportive cycle, enough to stabilize the labor market and provide relief to more vulnerable sectors.
Yet this cautious optimism contrasts with market behavior. Equities have rallied strongly, with the S&P 500 hitting record highs in September despite clear signs of labor market erosion. This divergence raises questions about the sustainability of the rally and the true health of the U.S. economy. Beneath the surface, however, resilience persists. Consumer spending and capital expenditure remain robust, driving earnings momentum.
Looking ahead, the combination of monetary easing, fiscal support, and potential regulatory stimulus could help revive lagging sectors like housing, manufacturing, and employment. This policy-driven recovery may broaden the equity rally beyond dominant large-cap tech names. Small caps, which are relatively cheaper, have shown signs of life as expectations for Fed cuts increase. However, for their outperformance to endure, further rate cuts are needed, and earnings visibility remains low. Markets will also be watching closely as U.S. Q3 earnings season kicks off in a couple of weeks.
Outside the U.S., China presents a different but equally nuanced picture. Household savings remain elevated, with deposits estimated over $20 trillion. Policymakers are working to channel this liquidity into long-term investments, aiming to stimulate the economy through wealth effects and capital market development. This creates selective opportunities for investors. High-dividend stocks and certain tech names stand to benefit from a liquidity-driven rally, ongoing sector competition and advancements of China’s AI capabilities. Elsewhere in Asia, both Taiwan and Korea should continue to benefit from the structural AI tailwind, and India- which is notable laggard this year—remain attractive from a long-term perspective and for portfolio diversification. India is caught in the cross-currents of U.S. immigration and trade policies, with Indian assets underperforming substantially. This presents an opportunity for long-term investors to add exposure, as the domestic structural growth story remains intact, pushing the Indian government toward further reforms.
In fixed income, credit spreads have tightened significantly across both investment-grade and high-yield segments, and the credit curve has flattened on strong technicals. We continue to prefer carry at shorter maturities while increasing Treasury duration, as global curves have steepened and duration should benefit from the upcoming Fed cuts while providing downside cushion if US economy slows down sharply. Select EM rates look attractive, with the recent move up in the China government bond yields dollar hedged China government bonds may act as the good diversifier in global portfolios. On the other hand, Gold still offers diversification, though upside may be limited given its strong rally in 2025.
We are entering a phase of policy recalibration. The Fed is neither slamming on the brakes nor flooring the accelerator. Instead, it is steering cautiously through a complex macro landscape—marked by labor market fragility, inflation ambiguity, and geopolitical uncertainty. For portfolios, this means staying diversified and nimble. Exposure to real assets, quality credit, and select equity sectors—both in the U.S. and abroad—can help navigate this environment. A gentle easing cycle may not spark fireworks, but it could provide the steady support needed to sustain growth and market performance into 2026.
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