Core Viewpoint - The market is currently debating the potential for the Federal Reserve to cut rates aggressively, with expectations shifting towards lower rates than previously anticipated [1][2][3]. Rate Expectations - The market is pricing in a terminal rate of 3%, but there are indications that the Fed committee may lean towards lower rates, as evidenced by five members suggesting rates below 3% in the September dot plot [2][3]. - Labor market weakness could further push the Fed to lower rates below the 3% mark, indicating a divergence between market expectations and Fed sentiment [3]. Market Signals - The two-year yield is not trading as low as expected given the terminal rate pricing, suggesting that the market is sending a message about inflation and growth expectations [4]. - Current nominal real GDP growth is around 2%, which should align with the two-year rate, but the market's behavior indicates a different outlook [4]. Equity Market Outlook - The consensus earnings forecast for the S&P 500 for the next year is approximately $300, raising questions about potential price-to-earnings (P/E) ratio movements [5][6]. - There is speculation about whether there will be P/E compression or expansion, with some suggesting that markets could reach valuations above 7000, which may seem excessive [6]. - Despite concerns about equity market valuations, traders appear reluctant to sell, indicating a current lack of compelling reasons to exit positions [7].

Group 1 - The focus is on upcoming inflation data and its potential impact on equity markets and Fed fund expectations [1][2] - A hotter than expected inflation print would necessitate a higher discount rate, negatively affecting earnings and equities, while a downside surprise would have the opposite effect [2][3] - The current terminal rate is priced at 3%, aligning with the Fed's neutral stance, but a more dovish outlook could indicate recession territory, which is unfavorable for stocks [3][4] Group 2 - The market assumes the Fed prioritizes the labor market over inflation, suggesting that a hot inflation print may only cause minor fluctuations in equity markets [4][6] - There is skepticism regarding the transitory nature of inflation, especially if driven by tariffs, which could lead to higher oil prices and breakevens [6][7] - Higher yields are expected as inflation data comes in hotter, but immediate changes are not anticipated until there are signs of persistent inflation [7][8] Group 3 - Elevated valuations do not predict equity returns but can increase investor nervousness, leading to more severe sell-offs during downturns [8][9] - Vigilance is advised in the current market environment due to potential negative catalysts, rather than outright selling [9]

Investment Rating - The report has shifted its forecast for the next 25 basis point (bp) rate cut to September, previously expected in December, and has lowered the terminal funds rate forecast to 3-3.25% from 3.5-3.75% [2][3][22] Core Insights - The report indicates that the odds of a rate cut in September are somewhat above 50%, driven by underwhelming tariff effects, larger disinflationary offsets, and potential labor market softness [2][13][10] - The expectation is for three consecutive 25bp cuts in September, October, and December 2025, with additional cuts anticipated in March and June 2026 [3][22] - The report highlights that recent evidence suggests tariff effects on consumer prices are smaller than previously expected, contributing to a more favorable environment for rate cuts [5][4][10] Summary by Sections Rate Cut Forecast - The forecast for the next rate cut has been moved forward to September, with expectations of three 25bp cuts in September, October, and December 2025 [2][3][22] - The terminal rate forecast has been reduced to 3-3.25%, reflecting a change in outlook regarding the economy's performance at higher interest rates [14][18][22] Inflation and Tariff Effects - Recent comments from Fed officials indicate potential support for a cut in September if inflation data is not excessively high [4][6] - Evidence shows that tariff impacts on consumer prices are less significant than anticipated, with moderating wage growth and weak demand for travel providing additional disinflationary pressure [5][10][11] Labor Market Dynamics - The labor market remains healthy, but job openings are slowly declining, making it harder for unemployed individuals to find jobs, which could influence the timing of rate cuts [10][11][12] - Near-term risks to payrolls are noted due to changes in immigration policy and residual seasonality, which could prompt earlier cuts if employment data shows weakness [10][13]