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The Fed remains at the forefront – mostly dictating the daily action in financial markets. It seemed investors’ attention had shifted back to actual operating fundamentals during the first quarter, but now it feels like those gains were fueled partly by unrealistic hope for five or six rate cuts this year. Relentlessly strong economic data have quashed that notion, and stocks have pulled back as “higher for longer” is now more likely. Our belief has always been that six cuts would only come in response to a rapid economic downturn, which certainly wouldn’t be good for stocks. If forced to choose between low interest rates and a bad economy or currently higher and stable rates and a thriving economy, we’ll take the latter every time. But thankfully we don’t have to choose.

The economy is showing few signs of weakness despite the Fed’s currently “restrictive” posture, and each additional strong data point gives the Fed cover to hold rates steady. Inflation by most measures is in the mid-3s and Powell has signaled his intention to begin normalizing rates before the data hit the 2% target. So the first cut can’t be too far in the future. It’s a tricky spot to be in: do you risk recession by holding rates at restrictive levels too long or do you risk stoking inflation before that fire is out?

We think the Fed can achieve both components of its dual mandate in this cycle because they have several powerful allies on each front. Artificial intelligence (AI) will fuel massive increases in productivity across the economy, which is inherently disinflationary. ‘On-shoring’ initiatives, most notably in semiconductors, boots demand for materials, goods, and labor. And finally, immigration (if we figure it out) increases labor supply, which keeps wage costs from spiraling out of control despite a very tight labor market. All of this points to a very bright future for the American economy and for operating companies. It will be a welcome change when the Fed steps back and these important investment drivers dictate the action.


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