Strengths and Shifts

The economy has grown significantly since the last time it experienced a recession. Household incomes and financial savings stand at all-time highs, underscoring the strength of the past few years. Even faced with formidable headwinds-including wars, inflation, bank failures, and trade tensions-this expansion has endured and, more recently, even accelerated. Upgrades to GDP, fueled by improved capital investment and consumer spending, have reinforced this resilience. Moreover, forecasting models run by the Dallas and Atlanta Fed now project faster growth than earlier this year.

Linked to the recent success is the US stock market, particularly its large-cap segment. Broadly diversified large-caps are on pace to end 2025 with double-digit returns. If sustained, 2025 would mark the third consecutive year of such performance—an uncommon streak historically, often associated with periods of major technological transformation. While innovation plays a role, record-high corporate profits remain the dominant driver. Strong earnings continue to fund dividends and share buybacks, both of which have been critical in sustaining equity valuations.

Interestingly, foreign equities have staged a comeback this year, outperforming many U.S. benchmarks. The driver has been a weaker US dollar, which boosts the value of overseas assets when translated back into dollars. Combined with positive returns across many international markets, U.S. investors have enjoyed a “double benefit”—from both local equity appreciation and favorable currency movements.

Still, this year’s weaker US dollar seems anomalous with accelerating growth. An expanding economy should attract capital and strengthen its currency. Therefore, there must be other drivers. The other candidates could be inflation above global averages or expectations for decreased interest rates. The interest rate expectation fits nicely, assuming the Federal Reserve reduces interest rates used in monetary policy decisions soon. Probabilistically, inflation risks make less sense since the Fed would try to avoid rate reductions in those scenarios.

“At present, the weight of evidence still points toward ongoing economic expansion—and for now, corporate and market behavior remains firmly aligned with growth.”

Yet, not all data paints a rosy picture. Recent consecutive downward revisions to job reports by the Bureau of Labor Statistics hint at a softer labor market, and the Fed’s urgency to consider rate cuts may be another signal of caution. Employment trends will likely draw closer scrutiny in the months ahead.

Even so, long-term investors should avoid overreacting. Historically, modest upticks in unemployment have not been reliable signals to abandon equity markets. Businesses and capital markets tend to price risks early and adapt quickly. At present, the weight of evidence still points toward ongoing economic expansion—and for now, corporate and market behavior remains firmly aligned with growth.

Tariffs

Second quarter GDP had a surprise upward revision to 3.3%, and surged due to a significant decrease in imports due to increased tariffs, which subtracts from GDP. However, this strength was met with a deteriorating assessment of the labor market by consumers, with perceptions of job availability being the weakest in over four years.

Treasury Secretary Bessent was optimistic about the tariff revenue stream, stating it could reach “well over $500 billion a year,” significantly reducing federal deficits.

Trump explicitly warned of an “economic war” if the Russia-Ukraine conflict isn’t resolved, citing “very serious” consequences. We saw this manifest in the doubled, 50% US tariffs imposed on imports from India due to its continued purchases of Russian oil. Conversely, Mexico is reportedly considering new tariffs on China, potentially distancing itself from Asia and strengthening ties with the US ahead of critical trade negotiations.

China’s President convened a landmark summit, strategically embracing Russian and Indian leaders in a clear move to build an alternative to the US-led world order. While President Trump dismissed these gatherings as “largely performative”, other observers view them as a “meaningful shift” in diplomatic power, highlighting a growing front against US trade policies.

Adding to the complexity, President Trump’s tariff regime recently faced significant legal challenges. A federal appeals court struck down most of his tariffs, ruling that he exceeded his legal authority under the International Emergency Economic Powers Act and that Congress holds the exclusive power to impose taxes and duties.

While the tariffs remain in place pending further appeal, Trump strongly criticized the ruling as “highly partisan” and warned of a “total disaster” if tariffs were removed, indicating he would seek an immediate hearing from the Supreme Court.

Inflation & Jobs

Recent inflation data has been complex and generally mixed. July Producer Price Index (PPI) surged 0.7% over the prior month, well ahead of forecasts. This may suggest that businesses could pass some of these higher costs onto consumers. This came just days after the July Consumer Price Index (CPI) data showed inflation pressures were broadly in line with forecasts. Yet, the Fed’s preferred inflation gauge, the “core” Personal Consumption Expenditures (PCE) index, matched expectations but experienced its biggest annual rise since February.

Employment data continues to take focus. The July Job Openings and Labor Turnover Survey (JOLTS) report showed that the ratio of job vacancies to unemployed workers fell below 1 for the first time since April 2021, with job openings falling below expectations. Yet, economists suggested the labor market was slowing substantially but not signaling an imminent downturn.

Then came the crucial August jobs report, which revealed a dramatic slowdown, with fewer than expected jobs added and the unemployment rate rising to 4.3%. Further, June’s data was revised to show a loss of 13,000 jobs, the first outright monthly decline since 2020.

Finally, significant government revisions to employment data revealed that the US economy employed approximately 900,000 fewer people than originally reported for the 12 months ending March 2025. This indicates the labor market was much weaker and downshifting long before the summer.

This stark new evidence quickly fueled critics of government data collection, who argued President Trump inherited a weaker-than-expected economy and that Fed Chair Powell “has officially run out of excuses and must cut the rates now.”

Federal Reserve

Fed Chair Jerome Powell, in his highly anticipated speech at Jackson Hole, opened the door to a September rate cut, stating that the “baseline outlook and the shifting balance of risks may warrant adjusting our policy stance”. This announcement sent US stocks soaring and significantly increased market expectations for a rate cut at the next Fed meeting. This, combined with previous downward revisions to job growth, has all but sealed expectations for a September rate cut.

“A September rate cut looks nearly certain, but political pressure and legal challenges leave the Fed’s independence in the spotlight.”

President Trump recently escalated his criticism of the Fed as he announced his intention to terminate Fed Governor Lisa Cook, citing allegations of mortgage fraud. Cook, a Biden appointee, swiftly challenged this move as “unprecedented and illegal,” filing a lawsuit against Trump, the Board of Governors, and Chair Powell. This historic attempt—the first time a president has tried to fire a sitting Fed governor—has raised concerns about the central bank’s autonomy. If successful, Trump could secure a majority of his appointees on the seven-member Board of Governors. Some believe that such political involvement could erode the Fed’s credibility, impacting the American economy and consumers.

The White House has consistently criticized Powell for not acting sooner, arguing that delaying cuts hurts businesses and households. While a 25 basis-point cut in September appears almost guaranteed, the ongoing legal battle surrounding Governor Cook and the broader political pressure on the Fed mean that the path of monetary policy, and the institution’s independence, will remain a critical focus for investors in the months to come.

Stocks

A fascinating and somewhat unprecedented development in the relationship between the US government and corporate America has evolved, particularly concerning Intel. The US government recently converted $11 billion in grants into a 9.9% equity stake, marking an extraordinary intervention. Intel expressed uncertainty about whether other government entities might seek to convert existing grants into equity or if future grants could be jeopardized. There is also a risk that this move could harm Intel’s international sales, especially given that 76% of its revenue last year came from outside the United States. President Trump expressed his satisfaction with the deal, claiming the government paid “ZERO” for Intel and stating his desire to make similar “lucrative deals” that make the “USA RICHER, AND RICHER”.

From a broader perspective, stocks had another great month in August, continuing the rally. Small caps had a strong month, returning over 7%, far outpacing large caps. However, the trailing one and three year returns for large caps far exceed those of small caps. Foreign stocks also performed well, generally in line with US stocks on average across large and small caps.

With the high expectation of a Fed rate cut, some believe this monetary policy shift will fuel further stock market acceleration. However, stock markets tend to forecast these changes quite well and adjust prices accordingly. Still, plenty of uncertainty exists with tariffs and the economy, which will continue to impact stock prices.

Bonds

Bonds were influenced heavily by the sudden, near-certain expectation of a rate cut by the Fed as a result of Powell’s Jackson Hole speech and the recent labor market data. Ultimately, there has been a divergence between the short-end of the yield curve, gaining from a potential dovish shift by the Fed, and the long-end of the yield curve, which has climbed due to the “inflationary potential” of a less independent Fed and higher borrowing costs.

Overall, bonds performed well in August. Although shorter-term bonds outperformed longer-term bonds, corporate and high-yield bonds also performed well. Yields across corporate, high yield, and longer-term bonds are likely quite attractive to many investors. Yet, the trailing total returns for many bond segments are still quite unattractive due to the rising rate cycle from the recent past, which is still fresh in the minds of many investors.

The ongoing tension between immediate rate-cut expectations and long-term inflation and fiscal concerns means that the divergence between short- and long-term yields will likely remain a key feature of the bond market for some time.

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Bureau of Labor Statistics. Unemployment Rate, Total Nonfarm Employment, Labor Force Participation, Consumer Price Index, Producers Price Index. www.bls.gov. United States, Department of Commerce, Bureau of Economic Analysis. Personal Consumption Expenditures, Gross Domestic Product, Consumer Spending, Personal Income and Outlays. www.bea.gov. Federal Reserve. Fed Funds Rate, Fed Funds Target Range, Minutes of the Federal Open Market Committee, Board of the Federal Reserve System Calendar. www.federalreserve.gov. Trump, Donald. @realDonaldTrump. Truth Social.