Outlook

October 1, 2025

Fed’s "Summer" Solstice Ends; Fall Cuts Spur Stocks & Bonds

A year ago, following a 50 basis point (bp) cut, the Federal Reserve’s so-called dot plot, (the graphic depiction below of where each voting member forecasts interest rates) projected 100 bps of cutting in the year ahead.

So far this year, there has only been one quarter-point rate cut (on September 17), though the markets have already priced in two more in November and December. That’s in line with the Fed’s own dot plot below (though far short of what the president has wanted).

What the Fed couldn’t have modeled a year ago were several major developments: 1. Donald Trump returning to the presidency; 2. His massive restructuring of global trade including higher tariffs; 3. An acceleration of the federal deficit, and; 4. A tightly sealed southern border and the start of deportations that may (emphasis on may) increase labor costs, particularly in agriculture and homebuilding.

As for trade, the Fed has consistently said that it would keep interest rates steady as there’s a risk that rising import prices might exacerbate inflation. So far, there’s only anecdotal evidence of that. However, some economists expect trade’s new ground rules to take 12-18 months to fully work their way through complex supply chains. Only then will it be known if the Fed’s cautionary stance has been prudent.

As to last month’s cut to a range of 4.00% to 4.25%, the Fed has its eye on its other mandate: full employment.

As is typical with economic indicators, the employment outlook is inconsistent. While there’s been a noticeable slowdown in hiring (especially among new college grads) and layoffs in tech (some attribute that to AI), recent first-time unemployment claims don’t (yet) reflect corporate “right-sizing.” Indeed, the nation’s official unemployment rate was 4.3% in August — essentially unchanged from the month prior and one year earlier (at 4.2%).

Having long anticipated September’s cut, stocks didn’t so much jump higher, but they did advance at a measured pace as the month unfolded. This begs the question: If stock investors welcomed lower rates, why did bond yields move back up (meaning that their prices fell)?

The first reason is that lower rates hold the promise of stepped up economic activity. But that can spell higher inflation. And the prospect of higher interest rates means that bond investors need to be paid more for their increased risk. As well, lower rates may mean more borrowing which is not good for current bond holders (think mortgage refinancings). Also, if the economy strengthens, assets may migrate out of comparatively safer bonds and into risk- assets like stocks and even high-yield bonds.

A Goldilocks Economy
That’s not a term I’ve seen lately, but with the country’s employment rate considered “full” (with unemployment between 4% to 5%), inflation elevated but seemingly moving in the right direction, interest rates trending lower, and indications that GDP growth may by accelerating towards 4%, plus corporate earnings expanding, it’s little wonder that stocks are trading at all-time highs.

That the mood on Wall Street is out-of-step with Main Street (consumer confidence is down) is worthy of understanding. It may be political in nature, and it may even be related to the "Great Wealth Transfer" from Baby Boomers to younger generations. While these discussions are better had over a beer, record market highs for stocks are not without risks, which are often under-considered.

Today’s historically high valuations are susceptible to profit-taking, while other risks include a prolonged government shutdown, sagging GDP growth (at home and abroad), a tech retrenchment (such as seen in the spring), and perhaps a rotation of assets into more attractively priced small- and mid-cap shares. Bonds, of course have other risks, especially longer-dated Treasuries. That, of course, is worthy of a separate conversation.

— John Bonnanzio