September started with continued upward momentum in the U.S. stock market as we begin to see the second wave of beneficiaries in AI headlined by Oracle’s big earnings surge last week. While it has been a strong year for the U.S. markets, international markets have expanded on a quick start from the beginning of the year and performed even better with both developed and emerging markets up over 24% YTD. Small cap stocks have done well, too. Even bonds have outperformed relative to their interest level up over 6%.

‍_{The Fed Announced Rate Cuts —Finally. So Far, So Good. What Should We Look for as We Head into the Final Months of the Year?}‍

All eyes were on the Fed this week, and news did they deliver. On Wednesday, the Federal Reserve announced its first rate cut in nine months. In addition to high court drama around the attempt to remove Fed Governor Lisa Cook, the Fed finally opted for a quarter-point cut, matching analyst expectations and markets rallied behind the news. The Fed said its decision was based on their two mandates: full employment and maintaining price consistency with an inflation target of 2%. This decision marks a critical moment for the Central Bank on how they will navigate future policies.

What Was Working Against the Fed Cutting?  

Inflation Still Above Target:  Inflation measured by CPI came in at 2.9% year-over-year in August (vs. +2.7% in July). Core CPI increased slightly to +3.1% YoY (vs. +3.05% in July).

Drivers include shelter (+0.4% from last month), food (+0.5%), gasoline (+1.9%), and used cars (+ 1.0%). There are also signs that tariffs continue to affect consumer goods prices including clothing, furniture and cars.

Why Will the Fed Probably Continue to Cut Despite Sticky Inflation?

The labor market, which has been historically strong since the economic recovery from the pandemic, continues to weaken. Jobless claims and unemployment have both increased to pre-pandemic levels.

Jobless Claims (week ending 9/6) came in at 263,000, a 4-year high and above economists’ estimates. Bureau of Labor Statistics (BLS) revisions show recent job growth was overstated by 911,000 jobs for the 12 months through March 2025.

August payrolls showed 22,000 jobs added, below estimates of 80,000. Finally, while still low by historical standards, the unemployment rate at 4.3% is the highest since late 2021.

The net result is that while the Fed did finally cut rates, the verdict for future rate cuts is divided; stronger economic growth and employment without a move toward lower sustained inflation could slow the Fed’s future rate cut decisions.

Things to Keep an Eye On: Trade, Tariffs and the Dollar

When will we actually know the impacts of tariffs on the economy?  We will have to wait a bit longer.

The Supreme Court has agreed to hear the Trump administration’s appeal of a lower court’s ruling that tariffs imposed under economic emergency powers are illegal. The case comes before the court in the first week of November. If the court rules with the lower court, the U.S. Treasury would be forced to refund more than $750 billion in tariffs already collected, potentially adding to the already stretched U.S. government deficit. On the other hand, we could see a meaningful rebound in impacted industries including consumer goods whose shares have sold off on perceived impact to their business from tariffs.

If tariffs are upheld, the increased prices of goods and services will either pass to consumers through inflation or reduce company profit margins.

Dollar Decline

Another rarely discussed impact on inflation and trade has been the weakening U.S. dollar, which is down over 10% YTD. One of the costs of the weak dollar is it makes imported goods more expensive, adding to the already heavy burden placed on buyers of foreign goods (consumers and importers) by tariffs.

While a declining dollar is a headwind to U.S. consumers, it creates a tailwind to foreign companies earning profits in other currencies which have appreciated relative to the dollar. This benefits U.S. investors in foreign companies and is a big reason MSCI EAFE has outperformed the S&P 500 so far this year.

How to Finish Up the Year

Investors have been rewarded in 2025 for maintaining diversification with nearly all asset classes performing well.  As we wait to see how key trends play out including uncertainty around AI dominance, the status of tariffs, and future Fed actions, prudent risk management involves avoiding overexposure to any one theme in portfolios.

• AI could continue to create additional winners but could also suffer from unsustainable expectations. We will continue to make sure we have enough of the “Mag 7” to participate, but don’t get overexposed.
• After all of the announcements, delays, changes to tariff levels, we are still waiting to see the full impact of the tariffs on the economy. Businesses have built up inventory and are likewise waiting to determine whether they will bear the cost of tariffs or pass them on to consumers.  We have the additional wildcard of a November Supreme Court date that could bring a surprise with Tariffs being repealed and create a tailwind for consumer goods companies, but expand an already large deficit impacting the bond markets.
• Interest rates will most likely continue to decline, but we still need to be prepared that inflation could be too persistent or even reignite higher causing the Fed to pause.
• There are so many directions the market and economy can go. Staying diversified should help investors participate and avoid fatal missteps.