Market Commentary: A Hot Economy Meets a Reluctant Fed

The economy is experiencing strong inflationary growth rather than stagflation, leaving the Fed behind the curve and creating a risk of later, more aggressive tightening.

• Stocks were flat last week, while the S&P 500 remained above its June peak and its 50-day moving average; the authors expect these support levels to hold and believe consolidation could eventually resolve higher.
• The authors’ base case is that the Fed remains on hold through year-end, although the probability of a September hike was around 60%; historically, the S&P 500 was higher one year after the first hike in four of the last five cycles.
• August payrolls rose by 162,000, lifting the three-month average from 20,000 to 71,000 after upward revisions; unemployment held at 4.1%, and the rate has stayed at or below 4.5% for 59 consecutive months.
• Private-sector employment increased by 224,000 over three months, led by healthcare with 80,000 jobs, while professional and business services, construction, manufacturing, and retail and wholesale trade together represented 88% of job growth.
• Nominal GDP growth is estimated near 6%, versus 4% in 2010–19, while August manufacturing and services PMIs were 54.6 and 55.4; input-price indices reached 71.1 for manufacturing and 72.6 for services.
• AI-infrastructure investment, trade disruptions and energy bottlenecks are driving shortages and higher costs: copper rose more than 40% over the year, diesel reached $5.85 per gallon and gasoline averaged $4.15.

Takeaway: The authors favor equities because employment and activity remain strong and companies supplying constrained inputs can benefit from higher prices, but they warn that delayed Fed tightening could ultimately require a larger and longer rate-hiking cycle, increasing volatility.