Macro Musings: Goldilocks probabilities have increased but the scenario remains elusive. Our base-case continues to be a mild stagflation, but we maintain high recession odds due to ongoing mixed signals in the economy. Specifically, if GDP growth is largely just a function of the AI race propping up the economy by stimulating business capex and household wealth effect spending, we view this as unsustainable (especially if risk markets ever reprice). There needs to be more evidence that productivity and pro-growth measures are broadening out US growth. Furthermore, recent labor revisions and signs of stress in the auto and transportation sectors are more typical of a recession or severe mid-cycle slowdown versus a soft-landing goldilocks. Given this, more Fed cuts are likely needed to stimulate the non-AI & rate sensitive sectors. It could come at the expense of inflation while tariff pressures feed through. All this will not satisfy the Fed’s unofficial third mandate (keeping L/T yields down).
Market Thoughts: We identify some interesting, and at times conflicting, market developments. It seems that rates, gold, and risk assets are pricing in multiple scenarios, where sequencing matters in terms of which one is correctly priced. For the Fed to ease more than what is priced-in now, the initial catalyst would likely be from the macro backdrop deteriorating or some credit event. That is never good for stocks. Therefore, the rise in gold is potentially discounting the fact that highly indebted nations eventually go back to major easing measures (like ZIRP/YCC). However, we think the high valuations in equities, tight credit spreads and low vols are all driven by passive flows and complacency. We think markets are due for a correction at a minimum and are just looking for a catalyst.
Fed and Rates View: We expect the Fed to cut at each remaining meeting in 2025. The issue is that this is priced into forwards and there is risk for disappointment if the Fed takes an extended pause in early ‘26. That said, we discuss the potential fundamental & non-fundamental drivers of jumbo rate cuts.
US Policy Updates: The House narrowly passed a stopgap funding bill on Sep 19 that would extend government funding until Nov 21, but it failed to receive the minimum 60 votes that are needed in the Senate (where Republicans hold a 53-seat majority) to pass spending legislation without resorting to budget reconciliation (which can only be used once a fiscal year). To be resolved expediently, 7 Senate democrats would need to compromise and go with the House GOP’s continuing resolution. If a shutdown lingers, it will end up delaying upcoming economic data releases (i.e. NFP) and likely dampen risk taking.
Special Topic - Foreign Flows and the Asia FX Reserves Connection: We explore recent flows into US assets and how Asia amassed its large stock off FX reserves, why they are no longer growing as fast, with clear implications for UST demand.