Hawkish cut

Bottom line

The data drought resulting from the federal government shutdown continues. Despite this, on Wednesday the Federal Reserve cut interest rates by a quarter-point for its second consecutive policy-setting meeting. That lowered the target range to 3.75-4%, a three-year low.

The meeting was somewhat unusual in that it featured a rare double dissent on both sides of the announced decision. Fed governor Stephen Miran dissented in favor of a more aggressive half-point cut, while Kansas City Fed president Jeffrey Schmid favored no change. But the middle prevailed, with the majority essentially saying the deterioration in the labor market outweighed inflation concerns. This view was facilitated, we believe, by last week’s benign report on consumer inflation. Core CPI rose 3% year-over-year (y/y) in September, a tick below August’s 3.1% y/y increase and September’s consensus expectations for a 3.1% y/y gain.

PCE readthrough? With the September CPI data in hand, the core Personal Consumption Expenditure (PCE) index (the Fed’s preferred measure of inflation) was expected to be unchanged at a 0.2% month-over-month (m/m) increase and a 2.9% y/y increase in September, but the data was not reported today because of the government shutdown. In its September Summary of Economic Projections (SEP), the Fed is expecting core PCE inflation to rise 3.1% by the end of 2025. However, in his post-meeting presser, Chair Jerome Powell said policymakers expect the September reading to hit 2.8% y/y.

Fog of war In its September SEP, the Fed telegraphed the potential for two more quarter-point rate cuts this year. Powell seemingly threw cold water on that: “A further reduction in the policy rate at the December meeting is not a foregone conclusion — far from it.”

So, while the S&P 500 had risen to another intraday record of 6,920 earlier on Wednesday, it has declined by about 1.5% over the past two days, as bond investors have pulled in their horns regarding bullish slam-dunk expectations for that potential December cut (expectations have slimmed from 95% to 63% today). We here at Federated Hermes still anticipate it, though, with three more quarter-point cuts coming by the end of 2026. That would take the terminal fed funds rate to 3.0%. Embedded in our forecast is our expectation that the Fed will have more dovish leadership after Powell’s term expires in May 2026.

Quantitative tightening (QT) will end The Fed will end its QT program on December 1. The Fed had doubled its balance sheet to $9 trillion through quantitative easing (QE) during the Covid pandemic to lower Treasury yields and inject liquidity into the economy/financial markets and help to lift the US out of its deepest recession in history. The plan worked, and the Fed decided three years ago to slowly reverse the process. Its balance sheet has shrunk to $6.6 trillion. The new strategy is to freeze the balance sheet at about 21% of current-dollar GDP (about $30 trillion at present). According to the Wall Street Journal, that’s down from a 35% peak in 2022 but above the pre-pandemic 18% level. Strategas says that maturing mortgage-backed securities (MBS) of about $17 billion will be reinvested in Treasuries each month, which it says is the equivalent of an additional quarter-point cut from the Fed.

Data or no data, the US economy is raking Third-quarter GDP was supposed to have been flashed yesterday, but that didn’t happen because of the government shutdown. From a decline of 0.6% quarter-over-quarter annualized in this year’s first quarter, GDP rebounded to a powerful surge of 3.8% in the second quarter. The Bloomberg consensus expects a 3.0% gain in the third quarter and the Atlanta Fed is expecting a 3.8% jump, although the Blue Chip consensus is modeling a paltry 1.5% improvement. We are forecasting a 3.1% increase. 

Successful APEC summit The annual meeting of the Asia-Pacific Economic Cooperation (APEC) summit occurred in South Korea this week, aimed at promoting free trade and economic growth among 21 member economies in the Asia-Pacific region. President Trump was busy, announcing trade deals with Japan, Vietnam, South Korea, Cambodia, Thailand and Malaysia. 

The heavyweight bout was the much-anticipated meeting between Trump and Chinese President Xi Jingping. China agreed to a one-year pause on rare-earth export controls, said it would purchase 12 million metric tons of US soybeans by January and a minimum of 25 million metric tons annually in each of the next three years and agreed to help stop the flow of fentanyl into the US. In exchange, the US lowered tariff levels. Trump will travel to China in April, and Xi will visit Washington in next year’s second half.

Robust third-quarter reporting season We are about two-thirds of the way through the S&P 500’s third-quarter reporting season, and the results are stronger than expected. For the first time in nearly four years, analysts increased their earnings estimates in aggregate. Typically, company management talk down expectations during the quarter, to artificially manufacture an upside surprise. But they didn’t need to resort to such chicanery this quarter.

Revenues were expected to increase an estimated 6.3% y/y, but they have risen 9.1% thus far. Revenues grew 6.4% y/y in this year’s second quarter and 4.8% y/y in the first quarter. Earnings per share were expected to grow an estimated 8.0% y/y in the third quarter, but they have soared 14.3% y/y so far, versus an 11.9% y/y gain in this year’s second quarter and a 13.1% y/y gain in the first quarter. Net profit margins are increasing in the third quarter, due to the improvement in productivity and the moderation in wage costs.

Equity markets seem to ignore negative seasonality Typically, the August-through-October period is the choppiest three-month block of the year, but that wasn’t the case in 2025. Strong fundamentals rule, as the S&P surged 8.03% on a price-only basis over the past three months, while stocks gained 8.35% on a total return basis.

Read more about our views and positioning at Capital Markets

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