Economic Resilience Continues to Impact Rate Outlook

This week’s data and market momentum solidified the case for a resilient U.S. economy, defying concerns of an imminent slowdown. Initial jobless claims dropped to a five-month low, reinforcing the strength of the labor market, while GDP growth projections hover around an impressive 2.5%. Despite seasonal adjustment issues clouding some of the continuing jobless claims figures, a broader trajectory of economic indicators points to an economy operating above expectations.

The outlook on Federal Reserve rate cuts is continually being reassessed and recalibrated. The July 2025 Fed Funds Futures suggest rates may only decline to around 4.1% by the middle of next year, implying many fewer cuts than previously anticipated. This reflects a reassessment of the so-called equilibrium rate—what I call the "R-star (R*)." I estimate this equilibrium short-term rate to be between 3.5% and 4%, significantly higher than the Fed’s projections. The Fed is unlikely to reduce rates as aggressively as many hoped.

While one-year inflation expectations have moderated to 2.6%, longer-term expectations have ticked up, with the University of Michigan reporting a 3.2% reading for five-to-ten-year inflation. This is the highest since the pandemic and warrants attention, as it is well above the Fed’s 2% target. However, stabilized commodity prices and the prospect of rental rate deceleration provide a counterbalance, suggesting inflationary pressures are unlikely to spiral out of control.

Equity markets continue to display remarkable strength. The S&P 500 and other major indices are flirting with or surpassing all-time highs. The breadth of the rally is particularly noteworthy, with a growing number of stocks hitting 52-week highs. Small-cap stocks, as represented by the S&P 600, are performing exceptionally well, closing at record levels. This breadth is a key signal of market health, as it indicates a robust and inclusive rally rather than one concentrated in a few mega-cap names.

Bitcoin has emerged as a standout asset, nearing the symbolic $100,000 mark. While I refrain from making specific forecasts in the crypto space, the broader resurgence of digital assets underscores shifting sentiment, particularly with the prospect of a crypto-friendly regulatory environment under the new administration. This aligns with renewed strength in risk assets more broadly.

Investors should remain vigilant about developments in Fed policy, especially as December’s FOMC meeting approaches. Key data points, including the upcoming CPI and employment reports, will shape market expectations for rate cuts next year. Additionally, fiscal policy under the new administration—particularly around tax cuts, tariffs, and potential deportation policies—will have significant implications for the economy, bond yields and equities.

With the holiday this week, we will not have a commentary next Monday, December 2 but will return the following week.

HAPPY THANKSGIVING!