Inflation Steady as Q4 Becomes Tariff Test

Inflation gave markets exactly what they wanted last week—no surprises. The PCE deflator matched expectations across all four metrics, reinforcing that the disinflation trend remains intact and that recent price pressure is coming largely from one-off tariff and policy effects rather than underlying demand. With inflation coming in as expected, the door remains open for the Fed to keep easing.

Beneath the calm inflation print, growth data firmed. Last Thursday’s durable goods report surprised to the upside and, importantly, the trade deficit came in much narrower than expected—two developments that pushed GDP estimates higher for the quarter. Some lifted Q3 GDP tracking into the mid-to-high 2s, with the FedNow St. Louis well over 3. The estimate of Q2 was revised up to 3.6%, though that is history; note that the first quarter was negative, leaving the first half still under 2%. Netting it all out, my base case for full-year 2024 remains roughly 2.4%–2.5%, with current-quarter growth running in the 2½–3% zone—healthy but not overheating.

The policy narrative is evolving in a constructive way. A new Fed governor, Steve Miran, laid out an analytically serious case this week for a materially lower neutral real rate, arguing population and labor-force dynamics, including immigration trends, have pulled r* down. I don’t buy all his points, he pegs neutral real near zero and implies a funds rate near 2.0%–2.25%, but I agree with the direction: slower labor growth does argue for a lower neutral than we had last cycle. My take is that a nominal funds rate around 3.25% better balances today’s inflation dynamics with growth resilience. With the effective funds rate near 4.09%, the Fed still has room to move. I expect two 25 bp cuts into year-end, including at the October 29 meeting, and I’d endorse continuing 25 basis point (bp) steps through the first half of next year if inflation stays near target and money growth remains restrained.

High-frequency indicators are holding in the sweet spot. Jobless claims have settled into a 200,000–240,000 range after the Texas distortion washed out, consistent with a labor market cooling to balance without cracking. If, as Powell suggested earlier, trend payroll growth consistent with stable unemployment has drifted toward 0–50k, then slower headline job gains shouldn’t scare investors—they would simply reflect the new trend demographics. In that world, productivity becomes the growth lever, and here AI-linked investment continues to push capital deepening that can sustain real GDP per capita. That’s the right kind of expansion, and it is equity-market friendly.

The near-term watch items are straightforward. First, tariffs: their bite should show most clearly in Q4 as holiday imports hit shelves. Second, the fiscal noise: a potential government shutdown at month-end could disrupt some data flow, possibly this Friday’s jobs report, though we’ll still get private reads like ADP on Wednesday. Third, the money supply: we’ll see the latest data this week, and I continue to emphasize that contained money growth is the best assurance that today’s inflation stability persists into 2025. None of these risks alter my baseline that the economy enters Q4 with momentum and inflation control.

Equities should continue to outperform nominal bonds as the Fed eases into strength rather than reacting to weakness. A glide path of 25 bp cuts lowers discount rates without signaling recession, supporting cyclicals and quality value; small caps should benefit disproportionately if financing spreads ease.