Bottom Line: 10yr
We don’t expect much of an increase in 10yr yields or the expected fed funds rate FROM HERE. A ~5% 10yr yields is the level where investors believe demand destruction sets in according to our surveys and the Fed is unlikely to signal a well above 4.5% fed funds rate (current expectations). Investors assume some slowing given the current 10yr level. As that slowdown happens, WHICH IS NECCESARY, Price Momentum, AI buildout names, EPS Momentum and the Cash Return factor will continue to outperform. Non-AI related Cyclicals (consumer, housing, transports) will suffer relative.
Relevant News: CPI (HERE)
After some early summer softness August’s inflation data was not dovishly accommodating and likely hot enough to push the Fed to a September hike. Market pricing at 85-90% also now makes the risks of a dovish surprise likely too much in the current backdrop, even if some officials still may not want to hike. The basic message remains one of corporate pricing power in the face of serial supply shocks amid solid demand growth and a stable labor market. There were distinct shocks higher in communication services, airfares, and hotels but we’re well past the point of idiosyncratic or exclusionary logic being particularly persuasive, esp. when some of those same series recent softness was pointed to in a dovish way earlier in the summer. The market reaction seemed to suggest that the data being just hot enough to induce a Fed hike(s), may well be a good thing when we’ve been worrying about excessively accommodative or inflationary policy choices.
Things to Watch [Consensus, Results]:
Strategy:
Don’t Expect Much of an Increase in 10yr Yields Even if CPI Data is Hawkish – (HERE)
Real GDP growth remains well above the economy’s roughly 2% speed limit, supported by both consumer spending and rapidly increasing AI-related investment. With AI investment unlikely to be a source of slowing over the next two years, more of the adjustment will likely need to come from consumer expenditures. We estimate consumer spending growth may need to slow from 2.5%+ currently toward 1%-1.5% to bring overall growth back toward a pace consistent with target inflation. Buildout baskets are showing tentative signs of rebounding, while Discretionary continues to come under pressure.
Financials:
Will They or Won’t They? Charting the course for Banks around Macro policy.– (HERE)
Bank stocks have lost momentum over the past month as higher oil prices, tariffs, the Bessent twist, and tighter financial conditions disrupted the “sweet spot” from earlier this summer. But with core CPI at 0.3% MoM and markets now pricing roughly a 90% chance of a Fed hike next week, greater clarity around the rate path could ultimately help the group. The bank-relevant 3M-5Y spread has widened to roughly 75–80bps from 50bps even as KRE has fallen ~5%, suggesting banks could catch up if that move is sustained. Banks are also broadly neutral to slightly asset sensitive, so a short 2–3 hike cycle could benefit earnings if deposit costs lag, while solid loan growth, credit, capital markets activity, and strong capital return remain supportive.
