September looms as a risk month for stocks, Yardeni says
The Fed I: Markets Hear Powell Cooing
We expected Fed Chair Jerome Powell to sound neither dovish nor hawkish when he spoke at the Fed’s Jackson Hole Symposium on Friday. We expected him to be owlish, expressing the need to wait and watch for further data before committing to another round of monetary policy easing. The financial markets expected that he would be dovish, and they were right, sort of.
Investors have believed that a Fed rate cut is likely in September ever since the weaker-than-expected July employment report. We’ve been pushing against this scenario. Powell did not push against it. He did not try to reset expectations. So that made the markets even more convinced that a rate cut is coming.
In previous discussions of monetary policy this year, Powell repeatedly said that the Fed is in no hurry to lower interest rates. He didn’t say that on Friday. The sentence in Powell’s speech that fueled Friday’s big stock market rally was the following:
“Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.”
In other words, the FOMC might cut the federal funds rate at the September meeting.
Needless to say, Powell included lots of hedge clauses in his speech. Immediately after he threw more gasoline on the stock market’s meltup, he noted:
“Monetary policy is not on a preset course. FOMC members will make these decisions based solely on their assessment of the data and its implications for the economic outlook and the balance of risks. We will never deviate from that approach.”
Those were his concluding remarks on the near-term outlook for monetary policy, which remains data dependent.
Powell did not mention that before the next FOMC meeting in September, there will be two important inflation indicators and another employment report. Presumably, the FOMC’s decision in September will depend on these data points. We continue to think they could confirm that inflation remains stuck around 3.0%—a full percentage point above the Fed’s 2.0% inflation target.
We are also anticipating that payroll employment rose 100,000 in August. That would be an increase from 73,000 in July (which likely will be revised) and confirm our view that the weakness in payroll gains during May and June was attributable to Trump’s Tariff Turmoil, which has abated since then.
Powell did discuss the current employment and inflation situations:
1. Employment
On the employment front, Powell noted that payroll jobs growth slowed to an average pace of only 35,000 per month over the past three months, down from 168,000 per month during 2024 (Fig. 1 below). But he also observed that the slowdown in jobs growth hasn’t “opened up a large margin of slack in the labor market” (Fig. 2 below).
The unemployment rate, he noted, has been historically low and broadly stable over the past year (Fig. 3). “Other indicators of labor market conditions are also little changed or have softened only modestly, including quits, layoffs, the ratio of vacancies to unemployment, and nominal wage growth” (Fig. 4).
Most importantly, in our opinion, Powell stated that
“[l]abor supply has softened in line with demand, sharply lowering the ‘breakeven’ rate of job creation needed to hold the unemployment rate constant. Indeed, labor force growth has slowed considerably this year with the sharp falloff in immigration, and the labor force participation rate has edged down in recent months” (Fig. 5 below and Fig. 6).
In other words, slower monthly payroll employment growth is not an obvious trigger for Fed easing.
Yet oddly, Powell concluded that “while the labor market appears in balance,” it “suggests that downside risks to employment are rising. And if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment.”
In our opinion, that’s an odd conclusion.
2. Inflation
On the inflation front, Powell noted that the current estimate for July’s core PCED inflation rate shows an increase of 2.9% y/y. He said that “is based on the latest available data.” It was 2.8% in June (Fig. 7 below). He estimated that core prices of goods increased 1.1%, “a notable shift from the modest decline seen over the course of 2024” (Fig. 8 below).
He noted that housing services inflation is falling, while nonhousing services inflation is “a bit above what has been historically consistent with 2 percent inflation” (Fig. 9).`
All eyes will be on July’s PCED inflation rate, which will be released on August 29. The core rate could be a bit hotter than Powell is expecting. The Cleveland Fed’s Inflation Nowcasting is tracking it at 3.0% y/y. August’s CPI will be released on September 11. Its core inflation rate is tracking at 3.1%.
If the FOMC eases on September 17 following such numbers, Powell will have to explain that the committee has judged that tariffs are having a transitory impact on keeping inflation around 3.0%, but it should soon be falling to 2.0%. The Bond Vigilantes might not be persuaded.
August’s employment report will be released on September 5. Naturally, all eyes will be on the month’s payroll employment gain (or loss). Just as important may be the revisions in the June and July numbers. Again, we are expecting a gain of about 100,000, which should be close to Powell’s breakeven monthly pace.
The Fed II: Fueling a Meltup
In his speech, Powell mentioned the word “stability” 11 times in the context of monetary policy’s dual mandate, which is to maintain low and stable unemployment and inflation rates. He did not mention that these can’t be achieved without financial stability.
A week ago, we wrote:
“Stocks will rise on expectations of another rate cut before the end of the year. What could be a better development for the stock market than another Fed Put when the economy doesn’t need the Fed’s help?! In this scenario, the Fed could very well fuel a wild meltup in the stock market. Valuation multiples would get even more stretched than they are already.”
Friday’s wild rallies in the S&P 500 and the Nasdaq 100 confirmed our assessment. So did the broadening of the stock market rally to riskier risk-on assets such as the US Small Cap 2000 and “story stocks” that have a good narrative but no earnings to show.
We concluded our analysis a week ago as follows:
“For the Fed, a stock market meltup increases the likelihood of financial instability. The Fed’s legal mandate is to keep both unemployment and inflation rates low. To do so requires financial stability. That should be the Fed’s third mandate since the Fed originally was created to avert financial crises.”
Powell did not mention that lowering interest rates might weaken financial stability. The notion was barely mentioned in the minutes of the July 29-30 meeting of the FOMC:
“In their discussion of financial stability, participants who commented noted vulnerabilities to the financial system that they assessed warranted monitoring. Several participants noted concerns about elevated asset valuation pressures.” That’s all, folks!
Expectations for a quarter-point rate cut in September surged following Powell’s speech, according to the CME Group’s FedWatch tool. Friday’s powerful and broad stock market rally in response to Powell’s comments suggests that investors are delighted with the prospect of another Fed Put, especially if the economy doesn’t really need it. Highly elevated valuation multiples were even more elevated after Powell’s speech, which hinted that the Fed is now ready to consider cutting rates again.
We are sticking with our targets for the S&P 500 of 6600 by year-end 2025 and 7700 at the end of next year. That’s our base-case scenario with a subjective probability of 55%. We currently assign a 25% subjective probability to a meltup that lifts the S&P 500 to 7000 by year-end 2025 and 20% odds to a correction in the index by the end of this year (Fig. 11 below).