Swaps markets are predicting a 100% chance the Fed will cut short-term rates by 25bp at tomorrow’s Fed meeting. Last week’s record BLS payrolls revisions of -911K for the year ending 3/31/2025, which implied monthly job growth of just +70K/month in the year ending 3/31/3025 vs previous estimates of +146K/month job growth, and the anemic August job growth of +22K have led several prominent economists to call for a 50bp cut at tomorrow’s meeting. The quarterly dot plot and Fed Chair Powell’s press conference will likely provide more insights about the Fed’s thinking than the rate decision itself. We expect a more dovish Jay Powell than in past Fed press conferences, given the suddenly weak U.S. job growth, and the much higher consequences if the Fed gets the employment side of the equation wrong in its dual mandate of driving maximum employment and stable prices.
At the current 10yrTY of 4.02% vs a S&P 2026 earnings yield of 4.6% (2026 P/E = 21.8x based on S&P 500 EPS of $300), equities are offering a +60bp premium vs risk-free bonds (historic premium 100-125 bp). Assuming 150bp in Fed easing by 2026 Y.E. (equal to 2026 Y.E. Fed funds rate 2.9%), equities would offer a +170bp premium vs treasury bills. We can make the case that absent a recession, equities still look cheap despite the S&P500’s +12% increase this year.
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