US Strategy Weekly: First Cut

The September Federal Reserve meeting is finally here and, in our view, the long-anticipated 25-basis-point cut in the fed funds rate is fully priced into stock prices. Nevertheless, barring some radical change in the economy, it is easy to build a case for 25-basis-point cuts in each of the next two Federal Reserve meetings this year. And since stocks tend to perform well in the six months following the first in a series of rate cuts, many forecasters, us included, are bullish for the rest of the year.

This bullish historical pattern related to Fed rate cuts may be why this September – a month that is typically the worst performing month in the calendar — has been kinder to equity investors than normal, at least to date. But there are a number of roadblocks ahead this month. The fighting in both the Middle East and Ukraine appear far from over and in some ways is growing more dangerous than ever. The fiscal crisis facing France continues, even with the appointment of a new Prime Minister. Fitch’s downgrade of France’s credit rating may be the first of several downgrades, and it is increasing France’s borrowing costs and deepening the crisis. And as President Trump arrives in Britain for an unprecedented second state visit, both the UK and the US face a similar combination of massive debt, weakening economies, and social unrest.

As we discuss this week, the fiscal year ends in September, and the government will shut down at 12:01 a.m. October 1^st without a new law to keep funds flowing. House Republicans are unveiling legislation to fund the government through November 21^st and it add security resources for government officials. But it is unclear if they have the votes to pass it. Democrats are demanding that any spending extension should tackle expiring health care subsidies that are due to expire at the end of the year.

The US debt crisis is real. In fiscal 2024, gross federal debt represented 122% of GDP and the Biden administration estimated this would soon rise to 130%. Debt held by the public (which includes the Federal Reserve but no other government agencies) was 97.8% of GDP in the same period.

Treasury Secretary Scott Bessent has indicated he has a long-term goal of lowering annual deficits to 3% of GDP. However, the administration’s attempt to balance the budget is proving difficult. Even though tariffs and capital gains taxes are adding to Treasury revenue, outlays for Social Security and Medicare are up 8% and 10%, respectively, in fiscal 2025. At the end of August, the 12-month sum of deficits equaled 6.3% of GDP, down from 7.2% in January, but still historically high. See page 3.

And since federal deficits remain large, public debt issuance jumped to $572.8 billion in July and remained high at $439.3 billion in August. (September auctions are estimated to be roughly $150 billion.) Quarterly data from the St. Louis Federal Reserve shows debt in Treasury bills was $5.78 trillion in June after peaking at $6.19 trillion in December. At mid-year this represented 16.4% of total federal debt, down from 17.5% at the end of 2024. The 3-month Treasury bill rate was 4.3% in June and the current 3-month constant maturity rate is 4.1%. More importantly, in fiscal 2024, interest expense represented 3.1% of GDP, higher than the 3.0% of GDP spent on defense. And though fiscal issues are not in the Federal Reserve’s mandate, this helps explain why interest rates are important to the federal deficit and why President Trump would like to see the fed funds rate lower.

In our opinion, the recent statement from the Bureau of Labor Statistics estimating a revision of 911,000 fewer jobs for the 12 months ending in March 2025, is a disturbing development. This means that job growth averaged 70,000 per month for most of 2024 and not the 147,000 as reported. This is certainly a reason for the Fed to be cutting rates.

And while inflation data for August was mixed it should not derail the Fed from lowering rates. Headline CPI rose 2.9% YOY in August, up from July’s 2.7% and the highest since January’s 3.0%. Core CPI was unchanged at 3.1% YOY. Only three segments of the CPI index showed inflation growing at or below 2% in August. Transportation, food away from home, medical care, and other goods and services all showed prices rising more than 3% YOY. However, while housing, with a weighting of 44.4% in the CPI, rose 4% YOY, it continued to ratchet lower. See page 4.

The problems in the CPI are concentrated in the service sector, areas such as motor vehicle maintenance and repair where prices rose 8.5% YOY in August. It is noteworthy that energy commodity prices fell 6.2% YOY in August, but energy services rose 7.7% YOY. While new vehicle prices rose only 0.7% YOY, used car prices rose 6% YOY. All in all, inflation issues do not appear to be tariff related. See page 5.

CPI, PPI, and import price indices have remained below the 3.5% long-term average for nearly two consecutive years; and with the fed funds rate at 4.33% and the PCE deflator at 2.6%, there is room for the Federal Reserve to have not one, but three consecutive 25 basis point cuts this year. See page 6.

Consumer spending was better than expected in August. Total motor vehicle unit sales were 16.5 million in August, up 5.5% YOY. And the impact of auto tariffs is clear from data that shows domestic light weight truck sales rose 12.5% YOY while foreign light weight truck sales fell 1.5% YOY. August retail sales surprised to the upside with headline sales increasing 5% YOY and sales excluding autos up 4.9% YOY. Retail sales for auto and other motor vehicle dealers rose 5.0% YOY in the first eight months of 2025. Miscellaneous store retailers saw sales increase 8.4% YOY in the same period and nonstore retailers had a 6.9% increase in sales year-to-date. See page 7. The consumer appears resilient.

Corporate earnings have also been resilient. In September, the 12-month sum of S&P 500 operating earnings showed a gain of 10.5% YOY. This was much better than analysts expected and is above the 75-year average of 8.1%. And though PE multiples are rich, the current earnings yield for the S&P 500 of 3.5%, when coupled with a dividend yield of 1.2%, comes to 4.7%. This compares well to a 10-year Treasury bond yield of 4%. Moreover, we expect positive earnings surprises will continue in coming quarters. From a technical perspective, the NYSE cumulative advance/decline line made a record high on September 15, 2025 and is bullish. The 10-day average of daily new highs is currently greater than 500, defining a broad-based advance. The AAII sentiment indices are more positive this week with recent readings showing bullishness at 28% and bearishness at 49.5%. This is nearing the 20/50 split that is rare and very positive. The one indicator that remains neutral is our 25-day up/down volume oscillator; and though this week’s reading of 2.00 is closer to an overbought reading of 3.0 or greater, it is still short of a five-day overbought reading needed to confirm the recent market highs. This suggests the volume on the advance in July and August lacked convincing volume, and it leaves the market vulnerable to a pullback. Nonetheless, we would be a buyer on weakness.

Gail Dudack

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