Macro
The key driver for markets this week was the increase in the PCE index, the Federal Reserve’s preferred measure of inflation. U.S. consumer spending rose in July at its fastest pace in four months, supported by solid income growth despite persistent price pressures. While households remain resilient, the outlook is becoming increasingly uncertain as job growth slows and inflation expectations edge higher. Core PCE climbed to 2.9% year-over-year, its highest level since February, and economists expect consumption to gradually cool as tariff-driven inflation and tighter financial conditions weigh on purchasing power.
Core PCE rose 27 bps month-over-month, broadly in line with expectations of 30 bps, and is projected to continue drifting higher through September and October, potentially peaking near 3.2%. June’s reading was revised up by +6 bps, while April and May saw slight downward revisions of -1 bp each. On a shorter horizon, 3-month and 6-month annualized core inflation came in at 2.98% and 2.99%, compared with 2.55% and 3.14% in June, respectively. Goods exposed to tariffs posted significant price increases, while other goods softened, leaving core goods inflation flat in July. Core services accelerated, driven by higher costs in financial services, insurance, recreation, education, and transportation.
Real personal spending increased 0.3% MoM in July, in line with expectations, while nominal spending rose 0.5%. Goods spending jumped 0.9%, likely in anticipation of upcoming tariffs, while services spending was up a modest 0.1%. Strong spending has so far been supported by real income growth, which rose 2.7% YoY in July. However, this tailwind may fade as slowing job creation, rising tariffs, and persistent inflation begin to erode household purchasing power.
Looking ahead, the labour market remains in focus. Fed Governor Christopher Waller indicated that payrolls may have shrunk over the past three months once benchmark revisions are applied, and private weekly data suggest job growth continued to weaken into August. With the personal savings rate falling to 4.4%, four consecutive months of declining home prices, and rising inflation expectations, markets anticipate a gradual cooling in consumer demand.
Fed Chair Jerome Powell emphasised that the “stability of the unemployment rate and other labour market measures allows us to proceed carefully as we consider changes to our policy stance.” While elevated inflation makes aggressive easing unlikely, markets expect the Fed to begin cutting rates in September with a 25 bps move, aiming to balance the risks of persistent price pressures against a softening labour market.
Rates
Inflation progress appears to stagnate as the inflation index is moving sideways and well above the FED’s inflation target. The latest PCE print came exactly in line with expectations but remains above the Fed’s 2% target, keeping the door open for easing while arguing for a measured pace. The market now expects the Fed to cut rates twice this year: 25 bp in September and another 25 bp in December. Expectations for next year are less defined, but pricing suggests roughly one 25 bp cut per quarter, implying a terminal target range of 2.75%–3.00%. Meanwhile, downward revisions to the July employment report have heightened downside risks in the labour market, shifting the Fed’s calculus toward a risk-management approach.
Policy remains data-dependent, and most anticipate an incremental easing path designed to preserve credibility while inflation stays modestly above target. Any cuts are expected to coincide with further curve steepening. Risk appetites, however, have improved as rate volatility cooled: the MOVE index has dropped from roughly the 98th percentile to around the 40th percentile. This repricing may be overdone given the Fed’s readiness to adjust policy, ongoing concerns around central-bank independence, and uncertainty tied to a potentially more dovish leadership transition.
In the bond market, the 10-year yield remains effectively anchored near 4.25% (within a few basis points), while the 2s10s spread has stayed close to 50 bps. The 5s30s steepener trade, popular since 2023, continues to have support, but participants remain cautious on the long end, citing fiscal dynamics and potential headline risks.
Political pressure on the Federal Reserve is rising, raising concerns over its credibility and market stability. President Trump’s attempt to remove Fed Governor Lisa Cook has triggered a legal battle and heightened fears about political interference. Former Fed counsel Scott Alvarez warned that allowing the White House to dismiss Governors on unproven allegations would undermine the Fed’s autonomy and unsettle markets. There is a risk that a more dovish Fed leadership could paradoxically increase economic risks by cutting rates despite persistent inflation. The potential appointment of a new chair would add uncertainty to the policy outlook and likely keep long-end yields elevated, especially against a backdrop of fiscal concerns and questions around institutional credibility.
Credit
Credit markets remain supported by strong technicals and still healthy fundamentals, but investors should become increasingly selective. The U.S. high-yield market continues to offer attractive all-in yields of around 7%, making it competitive with the equity market, which historically produced average returns of 8%–9%, but currently trades at historically high multiples. Investors recognise this, and the resulting large demand leads to tight spreads. Currently, we are seeing a 77 bps spread for US IG and a 258 bps spread for US HY. Global IG hit 81 bps on Wednesday, near the tightest level since 2007 (just before GFC).
Corporate earnings have broadly met expectations, refinancing needs have largely been addressed, and default rates remain relatively low at about 3% despite entering the third year of a high-rate environment. Much of this resilience stems from issuers locking in low-cost debt during the prior low-rate cycle, meaning many have yet to feel the full impact of higher financing costs.
Still, investors are urged to remain vigilant. While the broader market appears stable, risks are concentrated in pockets like leveraged loans, where the default rate peaked at around 6% (including distressed exchanges and restructurings) before moderating. One early warning sign of rising stress is the growing share of PIK (Pay-In-Kind) deals, where companies issue new debt to cover interest payments, an indicator that some balance sheets may be stretched. Going forward, avoiding defaults will become increasingly critical, and high-quality credit funds that carefully select securities and manage risk can still deliver attractive yields in the 7%–8% range while maintaining low default exposure.
Globally, investors are also turning attention to European credit markets, where instruments are trading at notable discounts relative to the U.S., even after adjusting for smaller market size and lower liquidity. For yield-seeking portfolios, Europe offers selective opportunities, particularly for investors willing to accept reduced liquidity in exchange for potentially higher risk-adjusted returns.
Equities
U.S. equities ended the week mostly lower, with small-caps outperforming slightly as the Russell 2000 posted a modest gain, while the Dow slipped 0.19%, the S&P 500 fell 0.10%, and the Nasdaq declined 0.19%. Energy led the market with a 2.47% gain, while Financials and Communication Services saw modest advances. On the downside, Utilities dropped 2.10% and Consumer Staples fell 1.69%, with other sectors posting smaller losses.
September seasonality suggests that stocks and bonds tend to move in tandem, a pattern particularly pronounced over the past four years. If upcoming rate-cut expectations disappoint, both markets could come under renewed pressure. U.S. equities currently face a negative convexity profile, leaving downside risks elevated.
The S&P 500 came under pressure as chip stocks sold off sharply following Dell Technologies’ earnings, which revealed weaker-than-expected demand for AI servers and lower profit margins. Although Dell beat consensus estimates on both sales and earnings, shares plunged over 10% on signs of slowing AI-related hardware demand. Nvidia declined in sympathy, weighing heavily on the broader index given its significant weighting.
Investors are closely watching Nvidia’s earnings for signals of weakness in the ongoing AI-driven capital spending boom, though capex may not be the best indicator for equity direction. Historically, capex peaks have lagged market turning points, while free cash flow has proven a more reliable leading signal, having topped out ahead of major downturns in both the 2021 hyperscaler cycle and the dotcom bubble. With hyperscaler free cash flow already trending lower and Nvidia’s earnings surprises declining for seven consecutive quarters, the risk of an eventual peak in AI-related equities is rising, even if not yet imminent.
Despite these pressures, several factors continue to support the broader market. Consumer spending remains resilient, AI growth themes remain intact, and trade headlines provided a slight tailwind. Nvidia’s Q2 results exceeded expectations, with datacenter revenue up 56% year-over-year, though compute revenue slipped sequentially and Q3 guidance, while above consensus, fell short of the most optimistic forecasts.
Retail earnings offered additional insight into consumer health. Premium shoppers continue to spend confidently, while middle- and lower-income segments face growing pressure, signalling an increasingly uneven demand backdrop for discretionary goods.
Looking at the broader picture, U.S. equities appear to be in the early stages of a structural bull market, underpinned by demographic trends and technological innovation. Millennials and Gen Z are entering their peak earning years and are set to inherit significant wealth, likely boosting equity participation over the next decade. At the same time, AI and blockchain are reshaping corporate profit pools and driving higher valuations, particularly across technology, financials, and healthcare.
From a macro perspective, policy and rates remain the dominant risk factors. As long as long-term yields stay within the 2% to 6% range, valuations should be supported by nominal growth and improving earnings. However, a sustained move above this range could pressure price-to-earnings multiples and trigger a broader market re-rating.
Despite intermittent volatility, the current environment lacks the hallmarks of a late-cycle peak. Investor scepticism remains high, and measures such as margin debt have not reached extreme levels. This suggests that recent pullbacks are more likely to represent healthy consolidations within a broader upward trend, rather than signals of an imminent market top.