• Jerome Powell appears to concede defeat and opens the door to a rate cut.
  
  
• Another leg of inflation and employment data comes before the next Fed meeting.
  
  
• The Fed must still fear the impact of tariffs.
  
  
• Political pressure looms large.
  
  
• US yield curve steepening.
   
  
• Watch the dollar for trouble.
   

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Financial markets cheered Fed Chairman Jerome Powell’s speech at Jackson Hole last week. Powell, in carefully worded observations, acknowledged that ongoing labour market weakness “may warrant” future rate cuts. Traders promptly rushed for the “easing” button, sending equities higher and the two-year Treasury yield tumbling. However, while Wall Street applauded the possibility of relief, the deeper story is one of structural imbalances and a fiscal overhang. Powell subtly acknowledged growth risks but did not address the policy dilemma: a central bank trying to stimulate the economy at the short end while fiscal dominance and political pressures cause havoc at the long end of the yield curve.


A Balancing Act at the Front End

The Fed funds target range of 4.25–4.5% is hardly punitive. Powell reminded that this is not far from the 70-year average of 4.3%. He also suggested that the neutral rate (R*) has drifted higher post-pandemic, reflecting demographics, productivity trends, and crucially persistent fiscal deficits. Markets, however, heard the word “cuts” and took it at face value. 

Chart 1: Real Rates have Modest Downside Opportunity Unless There’s a Crisis
(%)

Source: Bloomberg

US equities- Price-to-book at an all-time high

The US equity market, for now, refuses to blink, but the resilience looks increasingly precarious. Money flows have slowed, and leverage has reached historic highs. Margin debt has surpassed $1 trillion for the first time, as investors pour into leveraged ETFs and call options. It is a classic late-cycle cocktail: speculation driving gains but leaving markets highly susceptible to shocks. Valuations, too, are stretched. The S&P 500 price-to-book ratio of 5.3x is near its highest on record, and the price-to-earnings multiples are at levels that only look sensible if earnings continue to expand without interruption. Clearly, the risk-reward trade-off for US equities has rarely looked so asymmetric.

Chart 2: US Equities’ Price-to-Book Ratio at All-Time High (MSCI Index)

Source: Bloomberg

Nevertheless, while equities surged, the dollar eased modestly, and traders priced in a 25- to 50-basis-point reduction in interest rates by September. But the exuberance is precarious, in our view. Powell was at pains to stress caution: the Fed remains data-dependent, inflation risks remain unresolved, and the easing cycle is neither automatic nor guaranteed. In other words, markets are running ahead of themselves. We still have a cycle of labour market and inflation data before the next Fed meeting.

Why Stimulate Now? Tariffs, Consumers, and Corporate Fear

The pressing question is what a monetary stimulus in the current circumstances is meant to achieve. Inflation has not been beaten and growth has not collapsed. The problem is a toxic government policy mix that has paralyzed both corporates and consumers. We discuss this below:

Tariffs and Regulatory Uncertainty: US tariffs are now at their highest level in more than a century. The tariffs by no means are small tweaks at the margin; they are systemic taxes on supply chains. Corporates are deferring investment, citing “radical uncertainty” around trade policy and regulation. Surveys of CEO confidence show a marked downshift this year, as firms grapple with legal challenges and shifting tariff regimes. Capex plans are quietly being shelved. 

Consumers Squeezed: Households remain uncertain and under strain. Core inflation is still above 3%, with services inflation especially persistent. The average US household has effectively paid more than $1000 in tariff-equivalent tax annually. Wages are not rising fast enough. Real disposable income growth is anaemic. Consumers may still be spending, but at the cost of drawing down savings and leveraging balance sheets. A renewed bout of inflation could tip this fragile equation into outright household retrenchment.

Powell’s dilemma is clear: ease too early and risk embedding inflation; ease too late and risk a sharper slowdown in employment and consumer demand (and the wrath of the president).

The Structural Threat: Inflation’s Resurgence

At Jackson Hole, Powell conceded that tariffs may represent a one-time shock, but the risk is that they seep into services inflation. Inflation tends to become “sticky” once it infiltrates wage negotiations and service contracts. The risk of resurging inflation, therefore, is real. 

If tariffs continue to rise, the risk is not transitory price adjustments but a new structural floor for inflation. Unlike the disinflationary globalisation wave of the 1990s and 2000s, we are now entering an era of de-globalisation. That is a fundamental break in the macro regime.

The Fed Under Political Pressure

Overlaying all of this is the current political theatre. Powell’s term expires next May. The White House has hardly hidden its impatience with Powell, repeatedly demanding rate cuts, sometimes in starkly explicit terms. Powell insists that the Fed remains independent, but markets are far from convinced. Each dovish inflection is read as political capitulation. Independence, once lost, is hard to regain. 

For investors, the credibility of the Fed is as important as the level of rates itself. Without trust in the central bank’s independence, long-term expectations of inflation and the dollar’s status as reserve currency are at risk. Ratings agencies have already warned: the Fed is “the best defence” against a sovereign downgrade. Undermine that defence, and the fiscal cracks widen.

Enter Fiscal Dominance

This is the heart of the matter. US deficits remain at wartime magnitudes even during peacetime. The rolling 12-month deficit stands at about $2 trillion, which is 6.7% of GDP. Fitch projects a general government deficit of 6.9% next year, only modestly lower than 2024’s 7.7%. The debt-to-GDP already exceeds 120%, and interest costs are set to climb from 3.2% of GDP today to more than 4% within the next decade. 

This fiscal trajectory means two things for markets: 
– At the front end of the bond curve, the Fed can talk about cuts, and markets can price in some easing. 
– At the long end, relentless Treasury supply pushes yields higher, regardless of Fed intentions and never mind the political pressures. 

The result is policy incoherence: monetary easing offset, even negated, by fiscal excess. Investors demand more term premium, not less, when they sense the central bank is boxed in by fiscal needs.

Chart 2: US Yield Curve Steepening
(%)

Source: Bloomberg

Historical Echoes

The 1970s loom large. Then, as now, the story was not just about oil shocks (now tariff) but about fiscal profligacy and a central bank that was slow to act. Inflation became entrenched precisely because monetary policy was not free to dominate. The US risks repeating that mistake, albeit in a modern guise.

The parallel is not 1930’s Weimar hyperinflation, but it is troubling. A central bank attempting to “fine-tune” at the short end while fiscal dominance drives the long end higher is a recipe for policy failure. Powell may be today’s tightrope walker, but the rope itself is fraying.

Market Implications
For investors, in our view three factors stand out: 

1. Equities: Short-term relief rallies are possible, but earnings headwinds remain. Corporate margins face tariff and wage pressures, while companies postpone capex. Earnings forecasts were initially cut through the early months of the year before upgrades took hold in the third quarter. However, in recent days that positive trend has lost momentum and it is telling that the tech sector has seen some profit taking.

Chart 3: S&P 500 and Expected Earnings
Index, with earnings rebased to 100

Source: Bloomberg

2. Bonds: Duration is unattractive. Front-end yields may decline if the Fed cuts, but the long end remains hostage to fiscal supply and inflation risk. Curve steepening is the path of least resistance. 

3. Currencies: The dollar faces conflicting forces. Rate cuts would weaken it, but relative resilience against fiscally compromised peers (Europe, Japan) may provide support. The larger risk is credibility: if Fed independence is seen as compromised, the dollar’s premium erodes.

Blue-Sky Reflection: Where Does This End?

Imagine the scenario one year from now. The Fed has cut by 75 basis points, attempting to soften a slowing labour market. Long-term yields, however, remain stubbornly above 5 per cent, as deficits force massive issuance. Inflation, far from vanquished, resurges with sticky service costs and renewed tariff waves. Consumers, squeezed again, cut back spending. Corporates remain cautious. 

Powell’s “soft landing” slips into a hard plateau: growth anaemic, inflation elevated, policy credibility eroded. That is fiscal dominance in practice—monetary policy enslaved to fiscal needs, unable to deliver stability.

Conclusion

Jackson Hole was no ordinary exercise in central-bank communication. It was a moment of false comfort. Markets chose to hear the prospect of cuts. Powell chose to emphasise caution. The truth lies in the structural imbalances he dared not dwell upon. Inflation is not beaten. Corporates are not investing. Consumers are not flush. Fiscal deficits are not shrinking. 

The Fed can tweak the front end of the curve. The long end is beyond its reach. Until fiscal sanity is restored, the US risks living in a world where monetary policy follows rather than leads. 

The applause at Jackson Hole may prove fleeting. The harder question is whether Powell’s balancing act marks a path to stability—or the calm before the fiscal storm.

Fiscal Metrics Snapshot

Gary Dugan – Investment Committee Member

Bill O’Neill – Non-Executive Director & Investor Committee Chairman

26th August 2025

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