In short
A potential “Fed pivot” after Jackson Hole—Powell signaling more tolerance for inflation and greater focus on downside growth risks—could change the timing and market impact of rate cuts into year-end, increasing volatility even if returns remain mostly positive.
Guest backgrounds
No guests are interviewed in this transcript; it references colleagues Michael Gapin, Matthew Hornback, and Mike Wilson.
Key claims
Expect another Fed cut into September with a quarterly 25 bps pace; this path implies only slightly lower policy rates than futures pricing. Mostly positive fixed income and equities, but more volatility due to firmer-inflation tolerance.
Notable examples
U.S. Treasuries—possible curve steepening if long-end yields don’t fall as much; corporate bonds—constructive credit outlook if long-end yields don’t rise; stocks—risk of growth-stock valuation pressure if long bonds sell off, akin to early April.
Written by AI. May contain mistakes. Listen to the episode to check what was said.
Chapters
Tap a time to open that second in VOAnalyzing Fed's Shift in Policy
0:18 to 2:44
Discussion on the implications of the Fed's new tolerance for inflation and its impact on various asset classes.
“economics team flagged a subtle but important shift in U.S.”
Transcript
Automatic transcript. May contain errors.0:00Michael Zezas:Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income Research and Public Policy Strategy. Today, what a subtle shift in the Fed's reaction function could mean for markets into year-end. It's Wednesday, September 3rd at 11 a.m. in New York. Last week, our U.S. economics team flagged a subtle but important shift in U.S. monetary policy. Chair Jay Powell's speech at Jackson Hole underscored that the Fed looks more focused on managing downside growth risks and, consequently, a bit more tolerant of inflation. As you heard Michael Gapin and Matthew Hornback discuss last week, our colleagues expect this brings forward another Fed cut into September, kicking off a quarterly pace of 25 basis point moves.
0:44Michael Zezas:But while this is a meaningful change in the timing of Fed rate cuts, this path would only result in slightly lower policy rates than those implied by the futures market, a proxy for the consensus of investors. So what does it mean for our views across asset classes? In short, our central case is for mostly positive returns across fixed income and equities into year-end. But the Fed's increased tolerance for inflation is a new wrinkle that means investors are likely to experience more volatility along the way. Consider U.S. government bonds. A slower economy and falling policy rates argue for lower treasury yields.
1:22Michael Zezas:But if investors grow more convinced that the Fed will tolerate firmer inflation, the curve could steepen further, with the risk of longer maturity yields falling less or potentially even rising. Or consider corporate bonds. Our economic growth view is slower but still expanding, which generally bodes well for corporate balance sheets and thus the pricing of credit risk. That combined with lower front-end rates suggests a solid total return outlook for corporate credit, keeping us constructive on the asset class. But of course, if long-end yields are moving higher, it would certainly cut against overall returns potential.
1:58Michael Zezas:Finally, consider the stock market. The base case is still constructive into year-end as U.S. earnings hold firm, and recent tax cuts should further help corporate cash flows. However, if long bonds sell off, this could put the rally at risk, at least temporarily, as my colleague Mike Wilson has highlighted, given that higher long-end yields are a challenge to the valuation of growth stocks. The risk? A repeat of the early April dynamic where a long-end sell-off pressures valuations. Could we count on a shift in monetary policy to curb these risks? Or another public policy shift, such as easing tariffs or treasury adjusting its bond issuance plans?
2:36Michael Zezas:Possibly, but investors should understand this would be a reaction to market conditions, not a proactive or preventative shift. So bottom line, we still see many core markets set up to perform well, but the sailing should be less smooth than it has been in recent months. Thanks for listening. If you enjoy Thoughts on the Market, please leave us a review and tell your friends about the podcast. We want everyone to listen. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.
From the publisher
Fed Chair Jay Powell’s speech at Jackson Hole underscored the central bank’s new focus on managing downside growth risks. Michael Zezas, our Global Head of Fixed Income Research and Public Policy Strategy, talks about how that shift could impact markets heading into 2026.
Read more insights from Morgan Stanley.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income Research and Public Policy Strategy.
Today: What a subtle shift in the Fed’s reaction function could mean for markets into year-end.
It’s Wednesday, September 3rd at 11am in New York.
Last week, our U.S. economics team flagged a subtle but important shift in U.S. monetary policy. Chair Jay Powell’s speech at Jackson Hole underscored that the Fed looks more focused on managing downside growth risks and, consequently, a bit more tolerant on inflation.
As you heard Michael Gapen and Matthew Hornbach discuss last week – our colleagues expect this brings forward another Fed cut into September, kicking off a quarterly pace of 25 basis-point moves. But while this is a meaningful change in the timing of Fed rate cuts, this path would only result in slightly lower policy rates than those implied by the futures market, a proxy for the consensus of investors.
So what does it mean for our views across asset classes? In short, our central case is for mostly positive returns across fixed income and equities into year-end. But the Fed’s increased tolerance for inflation is a new wrinkle that means investors are likely to experience more volatility along the way.
Consider U.S. government bonds. A slower economy and falling policy rates argue for lower Treasury yields. But if investors grow more convinced that the Fed will tolerate firmer inflation, the curve could steepen further, with the risk of longer maturity yields falling less, or potentially even rising.
Or consider corporate bonds. Our economic growth view is “slower but still expanding,” which generally bodes well for corporate balance sheets and, thus, the pricing of credit risk. That combined with lower front-end rates suggests a solid total return outlook for corporate credit, keeping us constructive on the asset class. But of course, if long end yields are moving higher, it would certainly cut against overall returns potential.
Finally, consider the stock market. The base case is still constructive into year-end as U.S. earnings hold firm, and recent tax cuts should further help corporate cash flows. However, if long bonds sell off, this could put the rally at risk – at least temporarily, as my colleague Mike Wilson has highlighted; given that higher long-end yields are a challenge to the valuation of growth stocks.
The risk? A repeat of the early-April dynamic where a long-end sell-off pressures valuations.
Could we count on a shift in monetary policy to curb these risks? Or another public policy shift such as easing tariffs or Treasury adjusting its bond issuance plans? Possibly. But investors should understand this would be a reaction to market conditions, not a proactive or preventative shift.
So bottom line, we still see many core markets set up to perform well, but the sailing should be less smooth than it has been in recent months.
Thanks for listening. If you enjoy Thoughts on the Market, please leave us a review and tell your friends about the podcast. We want everyone to listen.