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Economic Cycle Dynamics are Driving 10yr Yields and Fed Funds Rate Estimates

Published on September 4, 2026

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Dennis DeBusschere

Kevin Brocks

Sophia Wang

DAILY STRATEGY: Fed Governor Waller noted that with the labor market and growth “in good shape… policy is currently only slightly restricting aggregate demand.” Investors don’t seem to agree on that restrictive point. The 10yr yield would not be flat since Waller’s more dovish than expected speech if investors believed policy was slightly restrictive. The expected Fed funds rate in December 2027 would not be pinned near recent highs if policy was seen as slightly restrictive.

Economic cycle dynamics are driving 10yr yields (HERE) and where investors think the Fed funds rate will ultimately go (higher). Including the expanding US deficit, AI debt issuance, 6%+ nominal GDP and a 4.1% unemployment rate. All these factors increase inflation RISK. That is why we are focused on cycle dynamics as the main driver of financial conditions.

FYI – Waller indicated he would not advocate for a rate hike even if the data from PPI/CPI, which we get next week, indicated 0.3% MoM core PCE inflation. That bar is high and helps explain why rate hike odds for September declined from 70% to 54%. That being said, if we got CPI/PPI data that indicate +0.3% MoM for Core PCE, 10yr yields are likely to move higher. That would be further evidence, for investors, that policy is not restrictive.

Inflation Cycle Drivers to Focus on Today. That Have a Long Shelf Life: As Gerard pointed out yesterday (HERE), consensus has factored in a 0.3% gain in average hourly earnings MoM. So, a modest MoM increase in wages after the unusually weak 0.1% MoM reading in July. If consensus is correct, that would allow the 12-month wage inflation measure to continue decelerating. That would be odd given that both productivity growth is firm, and recently firm inflation suggests that wage growth might be quickening. Consensus coming to fruition would be dovish – in the big picture. Especially if a consensus wage reading came with a higher unemployment rate. Investors in our survey (HERE) expect 4.2% urate vs the 4.1% Bloomberg consensus.

A 4.1% urate (or below) and stronger than expected wage growth would push back against continued labor market disinflation.

The inflation data is by far the main swing factor for financial conditions. But as noted above, we could get some longer-term disinflationary data today. And if we do, that will be positive for risk assets are reinforce our longer-term positive call on Early Cyclicals, Fundamental Factors (EPS Momentum, Earnings Growth, GARP) and would be a positive for small caps.

FYI – Risk-on factors, including Earnings Turbulence and Liquidity, along with Momentum and Growth factors outperform as financial conditions ease (the opposite when they tighten). With Momentum factors more AI driven their sensitivity with financial conditions has shifted more negative, especially Momentum of Price. This is likely due to the expected increase in debt financing for the AI buildout.

Charts –

It appears that investors don’t think policy is “slightly restrictive” the USD moved lower following Waller comments and gold and bitcoin increased. The negative correlation between the USD and Gold/Bitcoin has intensified (HERE).

Near term rate hike expectations decreased yesterday, but 2027 rate hike expectations are still near the recent highs.

Financial Conditions influence on factors – Financial conditions have been most positively correlated with risk-off factors such as Low Volatility and Quality of Earnings, along with Value factors. Risk-on factors, including Earnings Turbulence and Liquidity, along with Momentum and Growth factors outperform as financial conditions ease. With Momentum factors more AI driven, their sensitivity with financial conditions has shifted more negative, especially Momentum of Price.

Industry groups most sensitive to financial conditions currently are Energy, Commercial Services and Insurance, while Semis, Tech Hardware and Autos are most negatively correlated with financial conditions. Industry group relative performances since mid-Aug. have been positively correlated with their sensitivities to financial conditions as well.

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