Earnings Resilience and Policy Crosswinds

The third quarter saw the continued market recovery from the tariff induced selloff in April, as the impact on inflation so far has been more muted than initially feared, and the economy has remained resilient despite a softening labor market.

The returns for the major domestic stock market indices were:

During the period, the yield on the benchmark 10-year U.S. Treasury declined slightly from 4.23% to 4.15%. Rates on bonds of shorter maturities fell a little more, with the 3-month T-Bill moving from 4.41% to 4.02% while long-term rates did not move much at all, with the 30-year T-Bond down a nickel, from 4.78% to 4.73%.

Economic Overview

The quarter was highlighted by the Federal Reserve’s decision to cut the Fed Funds rate by 0.25% in September, the first time it has done so this year. The Federal has a dual mandate: maintain stable prices and support maximum employment. The factors that influence these two mandates have been at odds this year, further complicating the picture for the Fed. As shown in the chart on the following page, the number of jobs created by the U.S. economy has slowed this year, particularly since April in the wake of new tariff policies that went into effet on “Liberation Day”. Correspondingly, the unemployment rate has trickled up. The weakening labor market was the primary reason for the recent rate cut, and it could foster further cuts in the near future.

But, the Federal Reserve’s other mandate, price stability, is presenting challenges as inflation remains stubbornly above the Fed’s stated target of 2%. As shown in the chart below, the Fed’s preferred gauge of inflation, the Personal Consumption Expenditure (PCE) Price Index has started to tick up over the last few months as some of the inflationary pressure from the tariffs may now be starting to flow through to the consumer.