US Strategy Weekly: Two Notable Risks

There has been a string of data releases this past week, but the most important reports on employment and inflation for January are still ahead. The combination of these two releases could shift the consensus view on rate cuts in 2026, which now stands at one or two 25-basis point cuts and would bring the current range of 3.5% to 3.75% closer to 3% by year end. The FOMC dot plot projects only one 25-basis point cut this year, but the Fed’s dot plot is less a projection of interest rates than a data trend follower. And there is reason to be cautious about inflation since economic activity as measured by GDP has been strong. The 3.8% and 4.4% growth rates in the second and third quarters of 2025 were the best economic activity seen since the 4.7% and 3.4% rates seen in the third and fourth quarters of 2023. However, it is important to point out that inflation did not accelerate in 2023, and we do not believe it will accelerate this year either.

One reason inflation is less likely to accelerate this year is that employment costs are down. A recent employment cost index (ECI) report shows that total compensation, wages & salaries, and benefit costs for civilian workers each rose 0.7% in the final quarter of 2025. This was better than expected, and on a year-over-year basis, total compensation rose 3.4%, benefits rose 3.4%, and wages rose 3.3%. In each case, these were the lowest increases seen since 2021. See page 3. In the second half of 2023, the ECI was falling from a peak of 5.1% in the second quarter of 2022, but costs were still rising 4.4% and 4.2%, respectively. And despite this fact, inflation continued to decelerate. In our view, inflation is likely to slow in 2026 as well, particularly since crude oil prices remain relatively low. The fourth quarter deceleration in the ECI indices has been a positive for businesses and is showing up in recent corporate earnings releases as margin improvement.

The January jobs report will be an important data point for the Federal Reserve to ponder, but it will be a difficult report to analyze due to annual adjustments to seasonality and population benchmarks. Nevertheless, a weak employment report coupled with mild inflation could be a recipe for the dot plot to raise its estimates of rate cuts for this year. If so, it would spark more demand for equities.

Despite our concern about the weakening job market, there are signs that the consumer remains resilient. Outstanding consumer credit surged $24.1 billion in December, nearly five times the increase seen in November. Revolving credit, which includes credit cards and other short-term borrowing, grew $10.2 billion, or at an annualized rate of 13.4%. This gain was in sharp contrast to November’s annualized decline of 1.5%. Total credit grew 3.3% YOY, which was the highest growth rate seen since September 2023. Revolving credit rose 2.4% YOY, the first YOY increase since November 2024. We welcome this growth in consumer credit since negative revolving credit growth, like that seen in revolving credit recently, is closely correlated with recession. See page 4.

The advance estimate for retail and food services sales in December (adjusted for seasonal variation, holiday and trading-day differences, but not price changes), was $735.0 billion, virtually unchanged from the previous month, but up 2.4% YOY. Real retail sales rose 1.1% YOY. This report was viewed as a disappointment by most economists, but total sales for the 12 months of 2025 were up a healthy 3.7%. Nonstore retailers were up 5.3% YOY and food service and drinking places rose 4.7% YOY.

A separate report on vehicle sales was a concern since it showed that total vehicle sales were 15.4 million units (annualized rate) in January, down 6% month-to-month and down 3.5% YOY. Unit sales were reported to be 16.4 million in December 2025, down an even larger 5.2% YOY. In short, there has been a sharp 2-month deceleration in auto sales. A good part of this may be due to severe weather across much of the US but it is a trend worth monitoring since it could point to a weakness in consumption. See page 5.

The NFIB Small Business Optimism Index fell 0.2 to 99.3 in January. Seven components declined and the only improvements were in expectations for expansion, sales and credit. Hiring plans edged lower, and the uncertainty index, which dropped to its lowest level since mid-2024 in December, rose modestly in January. The most significant problems reported by small business owners were taxes (18%), followed by labor quality (16%) and insurance cost (13%). See page 6.

The University of Michigan consumer sentiment survey inched up to 57.3 in February from 56.4 in January, due primarily to the 2.9 point increase in present conditions, which rose to 58.3. Expectations slipped to 56.6 from 57.0. However, sentiment surveys have been in recession levels below 60, for ten of the last twelve months despite steady growth in the economy and retail sales. In our opinion, sentiment indicators have become victims of negative media coverage and are less useful than they had been in the past. See page 7.

All in all, recent economic reports show a healthy, although somewhat sluggish, economy. Fourth quarter earnings season, on the other hand, has been stellar. At present, the 12-month sum of operating earnings shows a gain of 16.7% YOY, far better than the 75-year average of 8.1% YOY. Consensus operating earnings estimates for the S&P 500 this year are currently $314.24 for LSEG IBES and $310.64 for S&P/Dow Jones. Our $315 estimate looked high in December when we published our outlook for the year, but it is becoming consensus view. But as we stated in December, our estimates are likely to prove to be too conservative. See pages 8 and 15.

Technical indicators continue to favor the bulls, even though our 25-day up/down volume oscillator, now at 1.78, remains in neutral territory. However, the 10-day average of daily new highs was strong at 553 this week and new lows ticked higher at 162. This combination of daily new highs above 100 and new lows above 100 lowered this indicator from positive to neutral last week. But most importantly, the NYSE cumulative advance/decline line made a new high on February 10, 2026, confirming new highs in the broad indices. See pages 10 and 11. Investors should be aware that the backdrop for the financial markets includes several risks. On the geopolitical front Israeli Prime Minister Benjamin Netanyahu will be visiting Washington this week to discuss possible military options against Iran with US President Donald Trump. There are reports that Israel is preparing contingencies should US-Iran talks collapse. We are also concerned about possible liquidity issues linked to cryptocurrencies following the roughly 45% decline in Bitcoin (BTC – $68,758.59) from its October peak of $126,000. One analyst estimated that there were roughly $10 billion in realized losses locked in by investors last week, the second-highest total since June 2022. Massive selloffs in one asset can create liquidity pressures that roll into other parts of the financial system. Nonetheless, we remain a buyer on weakness.

Gail Dudack

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