So much for summer doldrums

With a summer sizzle, stock markets have defied the usual seasonal doldrums, with the S&P setting record highs amid rate cut hopes. But with the Fed's independence under pressure, could inflation risks and consumer jitters bring a pre-winter chill for markets?

02 September 2025

Summertime in markets is supposed to be characterised by illiquidity and a lack of directionality, with the doldrums usually giving hard-pressed traders a chance to unwind at the beach. But this summer was marked by an increasingly stark divergence between economists and strategists panicking about tariff chaos and political influence on the Federal Reserve (Fed) on the one hand, and bewilderingly strong market returns on the other. The MSCI AC World Index returned nearly 4% in USD terms across July and August, with the S&P 500 returning 4.3% over the same period. Even a late-week dip in artificial intelligence (AI) stocks ahead of the US Labor Day weekend couldn’t derail the overall momentum of the summer holiday season. The S&P 500 notched five new record highs in August along, bringing its total for the year to 20.

Markets eyeing near-term rate cuts

The proximate reason lies in the belief that the Fed will cut interest rates at its next meeting in the middle of September. There are two drivers behind this. First is President Trump’s brazenly open attempts to pressure the Fed into cutting rates, per his move to oust Fed Governor Lisa Cook. Second is the fact that the US economy is showing signs of cooling as noted by Chair Powell in his recent Jackson Hole speech. Job openings over unemployment (close to a ratio of 1 now), along with recent sub-100k non-farm payroll additions reveal a slowing labour market. So it’s a case of bad news is good news again as the US administration applies pressure to reinstate the old Fed ‘put’, in which weakening data results in an almost instant accommodation on the part of the US central bank. Stocks of course love this, since a lower interest rate boosts the net present value of their earnings streams.

Fed up? Cuts could risk storing up longer-term trouble

But there are caveats. First of course is inflation. Cutting rates when inflation (currently 2.7%) is above the official 2% target almost seems to be asking for trouble down the line. The bond market appears to be obliging, with yields on short-dated paper falling so as to match lower expectations of rate cuts, while longer-dated yields have moved upwards to price in more inflation. This matters because longer-dated yields affect the housing market, long-term corporate borrowing costs and of course the financing of America’s huge budget deficit – and not in a good way. The second, related caveat is the effect on consumer confidence from all these policy shenanigans. Last week’s University of Michigan consumer sentiment index was already below expectations and consumers anticipating inflation may bring forward purchases only to suddenly stop them later. For markets of course, this is tomorrow’s issue. Right now the AI story remains intact (see Nvidia) and, combined with lower rates, accounts for this year’s benign summer. How autumn’s story pans out will now hinge heavily on that Fed meeting in a couple of weeks.

Trouble with the curve - expectations of low near-term rates storing up trouble for the future:

From 31 Dec 2024 to 1 Sep 2025