Author: Davis Finke, CFA
This week was headlined by a heavy slate of economic data covering growth, inflation, and employment, with the overall mix shifting expectations for Federal Reserve policy. On Wednesday, the Bureau of Economic Analysis revised second-quarter GDP growth higher to an annualized rate of 2.2%, up from the previous estimate of 1.5%, indicating that the economy carried more momentum into the second half of the year than previously estimated. Inflation data released the same day was also encouraging. The personal consumption expenditures (PCE) index, the Fed’s preferred inflation gauge, rose 0.3% in August, slightly below expectations for a 0.4% increase. Core PCE, which excludes food and energy, increased 0.2%, also coming in slightly better than expected. On an annual basis, headline inflation was 3.4%, while core inflation was 3.0%. Inflation readings for prior months were also revised lower, suggesting that price pressures have been running at a somewhat cooler pace than previously estimated. Friday’s jobs report pointed to a clearer slowdown in the labor market, with the U.S. economy adding just 29,000 jobs in September, well below expectations for 90,000. Job gains for the previous two months were also revised lower by a combined 60,000, while the unemployment rate increased from 4.1% to 4.2%. Prior to this week’s data, investors had expected the Fed to build on its September rate increase with another hike in October. Following the cooler inflation readings and weaker employment data, however, the market-implied probability of an October rate hike fell to roughly 23%, down from about 64% a week earlier.
Equities responded positively to the reduced likelihood of another near-term rate hike, with the major indexes rallying on Thursday and Friday after three consecutive days of declines. The late-week rebound was enough to push the tech-heavy Nasdaq into positive territory for the week, with the index gaining 0.63%. The S&P 500 finished down 0.28%, while the Dow Jones declined 1.27%. Technology was the strongest-performing sector, gaining 1.80% for the week and helping support the Nasdaq’s relative strength. Over the last month, technology is also the only sector with a positive return, gaining 8.95% since September 2. Energy and utilities were among the other stronger performers this week, rising 1.27% and 0.78%, respectively. On the other end of the spectrum, health care fell 2.68%, followed by financials and communication services, which declined 2.50% and 2.37%. Despite the late-week rebound in equities, elevated Treasury yields and oil prices remained important market headwinds. The 10-year Treasury yield reached its highest level since 2002 during the week as bond yields continued to move higher. Elevated oil prices have added to inflation concerns in recent weeks, contributing to upward pressure on longer-term interest rates even as this week’s inflation data offered some signs of improvement.
Treasury yields, inflation, and oil prices were recurring themes for markets throughout the third quarter. Even so, as we enter the final quarter of the year, the S&P 500 is up roughly 13% year-to-date and sits just 1.5% below its all-time high, demonstrating the market’s resilience despite elevated interest rates and higher energy prices. These macroeconomic factors will likely remain important market drivers, but attention will soon begin shifting back toward corporate earnings, which have remained one of the market’s most important sources of support. Third-quarter earnings season is just two weeks away, and S&P 500 profits are currently projected to grow roughly 30% in 2026, representing an unusually strong pace of earnings growth. Continued strength in corporate profits could therefore take on added importance as investors assess whether the market can maintain its momentum through the final months of the year.
