The August PCE inflation report confirmed that price pressures remain stuck in a holding pattern. Headline PCE rose 0.26% month-over-month and 2.74% year-over-year, while core PCE increased 0.23% MoM and held steady at 2.91% YoY. Inflation is not accelerating, but it is not falling quickly enough to reassure the Fed that the path back to 2% is secure.

The impact of tariffs on inflation remains modest. The current pace of price growth is similar to July, holding near the upper end of its historical range (excluding the COVID period). Within the PCE basket, goods excluding food and energy are rising at 1% year-over-year, which means that tariffs are having an effect, but firms seem to still be relying on inventories and absorbing cost pressures to maintain sales.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Bureau of Economic Analysis, Sage

Meanwhile, housing and core services continue to be the largest contributors to prices, and both continue to show a clear downtrend, which should help keep overall inflation subdued. Consumer activity remains resilient, with spending up 0.6% in August, surpassing consensus expectations.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Bureau of Economic Analysis, Sage

Last week Fed officials pushed back on the notion of imminent rate cuts in a barrage of speeches. Fed Chair Powell described policy as “modestly restrictive” and noted that tariffs have pushed some goods prices higher, but he also stressed that the pass-through remains small. He emphasized there is “no risk-free path” forward, a phrase that highlights the Fed’s balancing act. Cleveland Fed President Beth Hammack argued caution is still warranted given that inflation is above target, while Chicago’s Austan Goolsbee suggested there is room to cut if disinflation resumes, though not before the data confirm it. Richmond Fed President Tom Barkin emphasized the dilemma facing the FOMC, while Atlanta’s Raphael Bostic stated outright that he was hesitant to support a rate cut in October.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Bloomberg, Sage

Real yields jumped 20 bps after the FOMC meeting, injecting some uncertainty into the Fed’s path. Still, the broader trend points to lower rates. The next key data arrives this week with the upcoming labor market reports. An upside surprise to employment and wages would reinforce the Fed’s two-sided mandate risk, while weaker data could boost confidence that inflation will continue to ease. Job openings are likely to show declines in both demand and supply – a historically unusual dynamic. Additionally, new downside risk has emerged: a potential government shutdown. While past shutdowns have been temporary, they still hurt the real economy and would delay the release of labor data, adding uncertainty to the outlook.

 

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy, or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis, and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our website at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Pharmaceutical tariffs were among the final major trade actions anticipated after Liberation Day in April. The White House had delayed implementation to give drugmakers time to adjust manufacturing plans. On September 25th, President Trump announced a 100% tariff on branded or patented drugs from companies not building manufacturing facilities in the US, effective October 1st. While details remain limited, firms that have broken ground or are actively constructing US plants are expected to be exempt. As a result, most large US pharmaceutical companies are likely to see minimal impact, as the policy has already driven significant investment — industry commitments now total $325 billion.

The tariffs’ impact will depend heavily on whether they apply to individual drugs or to a company’s overall manufacturing footprint – details that remain unclear. International pharmaceutical firms without US investments, such as Novo Nordisk, could face greater disruption. Notably, generic drug makers were excluded from the announcement, which was a positive development for companies like Viatris, Teva, and Amneal Pharmaceuticals.

Announced investments have varied widely depending on the company, with Johnson & Johnson’s investment currently the largest at $57B, followed by AstraZeneca and Roche at $50B each. The tariff announcement also preceded a further $650M investment announced by AMGN on the morning of September 26^th. While details could change the ultimate impact, we view this announcement as better than feared as it removes a longstanding overhang for the sector.

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy, or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis, and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our website at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

As expected, the Fed cut rates at its September FOMC meeting, lowering the funds target range by 25 basis points – at 4.00% to 4.25% – after holding steady since December. The decision reflected recent weakness in labor markets, sparking concern over a growth slowdown even as inflation remains above target. The Committee’s updated projections point to additional cuts through 2025 and a steady glide path lower through 2027. In his remarks, Fed Chair Powell framed the move as a step toward neutrality — acknowledging that the balance of risks has shifted from inflation toward employment. This shift makes the MBS market’s continued strength especially noteworthy, reinforcing themes we’ve been tracking and suggesting further room for relative outperformance.

Agency mortgage-backed securities (MBS) are bonds backed by the cash flows of residential mortgages, most often issued through government-sponsored entities such as Fannie Mae and Freddie Mac. These securities carry minimal credit risk due to implicit government backing, but they are subject to interest rate risk, which alters prepayment speeds and cash flow timing.

One of the key measures of MBS relative value is the “mortgage basis” — the spread between agency MBS and comparable Treasuries. This spread compensates investors for prepayment and sector risks, and it typically widens when volatility rises. After blowing out to multi-year highs in 2022, the basis has steadily retraced. Today it is approaching the narrow levels last seen in 2023, after labor market weakness emerged as a key concern for the economy, and it now sits on the cusp of breaking below levels observed post-Fed hike.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Bloomberg 

At present, the current-coupon MBS basis is nearly 120 bps over Treasuries — a spread that still offers meaningful value. Investors can earn a greater yield pickup from owning AAA-rated MBS than from many lower-rated corporate bonds that carry credit risk. This dynamic underscores how much the sector continues to compensate investors for rate and prepayment uncertainty, even as spreads compress.

When interest rates fall, the duration of agency MBS shortens because borrowers are more likely to refinance early, which accelerates principal repayments and reduces a bond’s sensitivity to future rate changes. This creates a duration gap for benchmarked investors, prompting many to shift into longer-duration assets like Treasuries to stay aligned. At the same time, the need to hedge against convexity risk diminishes — shorter MBS duration means fewer Treasury sales for hedging purposes. These shifts in positioning and hedging can add momentum to the rate rally, supporting lower yields and reinforcing the relative strength of MBS.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Bloomberg 

Looking ahead, the backdrop for MBS continues to improve. The Fed’s pivot toward easing should help lower rate volatility, removing one of the sector’s largest headwinds. Banks — historically, the largest buyers of mortgages — are on stronger footing and may step back in as demand returns. At the same time, the contraction in MBS duration and the resulting hedging dynamics are already reinforcing the rally in Treasuries, creating a virtuous cycle that supports valuations. Layered on top is the political wildcard: the administration’s focus on driving long-term yields and mortgage rates lower. With policymakers ultimately setting the rules of the game, that “unknown unknown” adds another tailwind, leaving agency MBS well-positioned for the next stage of the cycle.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy, or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis, and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our website at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

The Federal Reserve cut its benchmark interest rate by a quarter percentage point at the September FOMC meeting, lowering the federal funds target range to 4.00%–4.25% in its first reduction since December. The move, widely expected by markets, reflects growing concern over a cooling labor market even as inflation remains above the Fed’s 2% goal. Officials also confirmed that balance sheet runoff will continue under existing caps, signaling that quantitative tightening remains in place despite the shift in rates.

Fresh projections from the Fed’s Summary of Economic Projections show policymakers expect the policy rate to fall to 3.6% by year-end, implying two more cuts in 2025, followed by a gradual decline to 3.4% in 2026 and 3.1% in 2027. Inflation is forecast to ease from current levels—headline PCE at 2.7% and core at 2.9%—toward 2.6% in 2026 and 2.1% by 2027. Growth estimates were revised slightly higher to 1.6% for this year, while unemployment is projected to rise to 4.5% at year-end before edging lower in the years ahead.

Fed Chair Jerome Powell repeatedly commented on the declining demand for labor. Powell characterized the policy change as a recognition of the shifting balance of risks between inflation and employment. While goods prices have firmed, partly due to tariffs, Powell noted that labor demand is weakening faster than supply, pushing unemployment higher and raising downside risks to jobs. He described the cut as a step toward a more neutral stance, emphasizing that the Fed remains committed to its dual mandate even as inflation risks persist.

Looking forward, Powell stressed that policy would remain data dependent. The updated dot plot reveals a divided committee, with some officials favoring no further cuts and others advocating a more aggressive path. Markets currently expect at least one additional quarter-point reduction this year, but Powell underscored that future moves would hinge on inflation trends, labor market data, and the evolving impact of tariffs. For now, the Fed is treading a narrow path—easing to support employment without reigniting price pressures.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy, or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis, and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our website at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

All eyes are on the FOMC this week, with markets broadly anticipating a rate cut. Market participants will be closely analyzing the dot plot, the Summary of Economic Projections, and Fed Chair Powell’s press conference for signals on the future policy trajectory. Meanwhile, a quieter but significant shift is unfolding beneath the surface. With the overnight reverse repo facility (RRP) nearly depleted, Treasury bill issuance now directly reduces bank reserve balances, draining liquidity from the financial system. This change elevates the importance of money market dynamics, as tightening liquidity conditions could amplify financial stress.

In the aftermath of the Global Financial Crisis, the Federal Reserve began paying interest on reserves as a tool to maintain control over short-term interest rates. However, this mechanism was limited to large depository institutions, leaving smaller entities — including government-sponsored enterprises (GSEs), regional banks, and money market funds (MMFs) — unable to earn interest directly from the Fed. These institutions sought alternative short-term investments, which became problematic when the Fed attempted to raise rates. Excess liquidity kept overnight rates low despite policy changes, prompting the Fed to introduce the ON RRP. This allowed smaller players to lend to the Fed overnight, effectively establishing a floor under short-term rates and improving the Fed’s ability to transmit monetary policy.

In the wake of Covid, the Fed injected trillions of dollars into the economy through asset purchases, much of which flowed into MMFs. With Treasury bill yields suppressed due to limited issuance and regulatory constraints, MMFs parked their cash at the ON RRP facility, which ballooned to $2.5 trillion as interest rates rose in 2022. Since that time, increased Treasury bill issuance pushed yields above the ON RRP rate, prompting MMFs to shift funds from the Fed to T-bills.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Bloomberg

This reallocation offset the liquidity drain from bond issuance, keeping the overall money supply stable. As T-bills have taken up a growing share of total Treasury issuance to fund the sizeable fiscal deficit, the ON RRP facility has been largely depleted. Going forward, each new round of T-bill issuance will require fresh capital from the market; otherwise, it will begin to pull liquidity directly from the broader financial system.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Federal Reserve 

As the ON RRP facility nears depletion, money markets are likely to become more sensitive to shifts in Treasury issuance and fluctuations in the Treasury’s cash balance. For the Fed, continued balance sheet runoff will intensify pressure on market liquidity, potentially complicating the effective transmission of monetary policy.

 

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy, or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis, and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our website at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Last week, the highly anticipated nonfarm payrolls report for August came in softer than expectations, printing just 22k jobs versus the consensus of 75k. Coupled with the downward revisions of -21k to prior months, the three-month average payroll is just under 30k, well below the pace needed to put downward pressure on the unemployment rate. This marks a sharp reversal from the robust labor market seen earlier in the year, which had been buoyed by a string of upside surprises in employment data through late 2024.

The shift in the health of the labor market is notable, especially as it coincides with other signs of labor market cooling. Job openings continue to decline, with the latest JOLTS data showing 7.2 million openings compared to 7.4 million unemployed — a ratio that has now turned negative after peaking at above 10 million in the post-pandemic recovery.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, BLS

The softening in employment data reinforces a dovish outlook for the FOMC. Interest rate markets are now pricing in a total of six rate cuts through early 2027, a notable shift in expectations compared to just a few weeks ago. Treasury Secretary Scott Bessent’s assertion from less than a month ago that “we should probably be 150 basis points lower” has quickly moved from contrarian to consensus. The market’s embrace of a lower rate trajectory reflects not only the labor data but also broader signs of economic deceleration, and it suggests that the Fed may have more room to ease than previously thought.

Meanwhile, longer-maturity yields have remained remarkably stable. Since the Fed officially ended its hiking cycle in July 2023, the 10-year Treasury yield has hovered around 4.3%. This range-bound behavior has been more pronounced this year as interest rates have been stuck between two dynamics — on one side, the drag from slowing growth, and on the other, the inflationary risks posed by tariffs. Recent labor market developments have shifted the balance, with the distribution of rate outcomes for the remainder of the year now tilted toward the downside.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Bloomberg

One area that may offer clues about whether we are truly in a regime change is the mortgage-backed securities (MBS) market. MBS spreads have recently tightened, approaching their narrowest levels since 2023. A decisive move lower could signal the onset of a new phase of Fed easing — one that not only supports rates and MBS valuations, but also drives broad-based strength across the entire spectrum of spread sectors.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Bloomberg

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy, or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis, and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our website at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Over the past month, the labor market has taken center stage in the debate over the near-term trajectory of Fed policy. With inflation not showing a meaningful pickup in aggregate, jobs data may be the lynchpin for near-term rate cuts. If employment weakens meaningfully, the Fed gains cover to ease; if not, they risk waiting too long.

One under-the-radar but powerful signal is the Conference Board’s “Jobs Hard to Find” measure. It comes from the monthly Consumer Confidence Survey, where respondents are asked whether jobs are plentiful or hard to get. The index is constructed as the share of people who say jobs are difficult to find. While it’s a sentiment-based indicator, it has a strong historical correlation with the unemployment rate, jobless claims, and payroll growth. In fact, it often leads official labor data, since consumers are reporting what they experience in real time rather than waiting for lagging statistics to catch up.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, BLS, Conference Board 

Lately, this signal has turned meaningfully higher. The “Jobs Hard to Find” share has been grinding upward and now sits at its most elevated level since the early post-pandemic recovery. In past cycles, similar moves foreshadowed tougher labor prints ahead. Households may already be picking up on a slowdown that the official data will confirm later.

If the survey is picking up on true labor weakness, this strengthens the Fed’s case for a series of rate cuts starting this month. At the September FOMC meeting, Powell and his colleagues will have to balance the threat of tariffs on inflation against a labor market that looks increasingly vulnerable. The “Jobs Hard to Find” measure may prove to be one of the early warnings that the cycle has shifted.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy, or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis, and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our website at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

The second-quarter earnings season offered a revealing snapshot of the US retail landscape. Retailers reported resilient consumer demand, driven more by pricing than volume. Comparable sales were broadly positive, with value-oriented retailers outperforming amid inflationary pressures and shifting consumer priorities.

Value retailers like WMT saw gains in both volume and pricing. Walmart (WMT) and off-price retailer TJX posted the strongest results, with comparable sales rising 4.6% and 4.0%, respectively. These value-focused retailers have consistently outperformed in a high-inflation environment, with each delivering 10 consecutive quarters of at least 3% growth. In contrast, more discretionary retailers like Target (TGT) continued to lose market share, with comparable sales declining 1.9% this quarter.

Home improvement retailers Home Depot (HD) and Lowe’s (LOW) both returned to positive comparable sales, reflecting some pent-up demand as the housing market begins to benefit from expectations of lower interest rates. A closer look at comparable sales reveals that much of the growth was driven by average ticket increases rather than higher transaction volumes. This trend was especially pronounced at HD and LOW, where:

• HD saw transactions decline 0.4%, offset by a 1.4% increase in average ticket.
• LOW experienced a 1.8% drop in transactions, countered by a 2.9% rise in ticket size.

Retailers are navigating a delicate balance — maintaining sales momentum while facing rising costs, particularly as tariff impacts begin to take hold. These impacts vary by retailer, with discretionary-heavy businesses (e.g., apparel and electronics) facing far greater tariff exposure. Tariffs are also highlighting the importance of scale and supply chain agility, both of which remain critical in mitigating cost pressures. Some retailers are destocking excess inventory purchased pre-tariff, leading to rising costs in the back half of the year. Others are experiencing upfront tariff impacts and are actively shifting supply chains away from China and other high-tariff jurisdictions while leveraging pricing strategies. WMT notably increased its inventory year-over-year in fiscal Q4 2025 and currently holds inventory 3.8% higher than the prior year. However, as WMT replenishes stock at post-tariff price levels, it is seeing weekly costs increase. Whether costs are absorbed in margin or passed on to the consumer is a question for the fourth quarter.

Tariffs are emerging as a key challenge, pressuring margins and prompting supply chain shifts, especially for retailers with heavy exposure to China. As costs rise and inventory strategies evolve, the sector faces a critical test heading into the holiday season, where agility and scale will be essential for maintaining profitability.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy, or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis, and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our website at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Fed Chair Jerome Powell’s speech at Jackson Hole last week marked a clear pivot from prior Fed communications, striking a more dovish tone than markets had expected. For much of this year, Powell emphasized patience and a cautious approach to easing. At Jackson Hole, he pivoted, acknowledging that the balance of risks has changed and that with inflation closer to target and policy already restrictive, “adjustments may soon be warranted.”

This shift did not come in a vacuum. Labor market data in recent months have been weaker than previously thought. Headline payroll gains have slowed sharply — from an average of over 200,000 per month in 2023 to just 35,000 in the most recent release — and downward revisions have erased much of the strength reported earlier in the year. The unemployment rate has edged up to 4.2%, and Powell described the current state as a “curious kind of balance,” one that results not from robust momentum but from a simultaneous slowing of both labor supply and labor demand. Such conditions, he warned, can tip quickly, raising the risk of a sharper deterioration.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, BLS 

Overlaying these cyclical concerns was a structural change in the Fed’s policy framework that was scheduled for this year. Powell confirmed the Fed is abandoning the “average inflation targeting” approach it adopted in 2020. That framework — designed for a world of weak demand, low interest rates, and chronic undershooting of inflation — allowed inflation to run above 2% for a time to make up for earlier shortfalls. The aim was to lift long-term inflation expectations and prevent premature tightening. But the post-pandemic economy is different. Tariffs have reshaped global trade, immigration has slowed, and repeated supply shocks have altered the complexion of inflation. In this environment, tolerating overshoots risks embedding inflation rather than raising expectations. Powell announced a return to a more traditional 2% target — flexible enough to acknowledge real-world frictions, but without the asymmetric bias that tolerated prolonged overshooting.

The combination of a stricter-sounding framework and a dovish policy stance may seem contradictory, but it reflects the Fed’s evolving calculus. Inflation is moving toward the target faster than expected, while the costs of holding policy at restrictive levels are rising. The new framework restores credibility to the Fed’s inflation objective, even as Powell’s tone makes clear that the near-term priority is guarding against unnecessary damage to employment. The timing of the shift is telling. It signals that the Fed is ready to exit the “higher for longer” phase and transition toward gradual easing, with September now squarely in play.

Political pressure provides another important backdrop. The White House has been calling for rate cuts to support growth and jobs, placing the Fed in a delicate position. Powell avoided any explicit reference, but by emphasizing labor-market risks and pointing to the downside of waiting too long, he effectively acknowledged the broader context. Maintaining independence while responding to real economic weakness is a fine balance, and Jackson Hole was Powell’s attempt to walk that line.

Markets took him at his word. Treasury yields fell across the curve, led by the front end, as traders quickly priced in a near-certain September cut. The yield curve began to steepen, reflecting expectations of a lower policy path and a Fed that is more responsive to growth risks than previously assumed. Real yields rolled over, and credit markets tightened in anticipation of an easier stance.

For fixed income investors, the debate is no longer about how long the restrictive policy will remain, but how fast the easing cycle will unfold and how far the Fed will ultimately go. The chart below shows the market implied probability of a Fed cut at the September meeting, which has hovered in a range since February. Following a steady decline after the latest weak labor data revisions, the market is now pricing in an 86% probability of a rate cut at the September FOMC meeting.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, Bloomberg

The message from Jackson Hole is clear: the Fed is pivoting from restraint to readiness. Inflation progress has given Powell room to maneuver, while weakening labor data and revisions have made the costs of inaction harder to ignore. September may well mark the start of a new phase in monetary policy — one where the focus shifts from fighting inflation at all costs to managing the risks of an economy that is already slowing.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy, or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis, and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our website at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

One of the most important but often overlooked macroeconomic shifts in recent years is the changing role of federal government spending in driving the real economy. While headlines tend to spotlight deficits and debt ceilings, the bigger story lies in how much the government spends relative to the size of the economy. This ratio, known as federal outlays-to-GDP, plays a critical role in shaping growth and increasingly shifts the responsibility for sustaining expansion onto the private sector.

As federal spending slows, the economy faces a headwind — unless consumer demand, corporate investment, and productivity gains, especially from AI and automation, step in to fill the gap.

Tracking the Government’s Footprint

Federal outlays as a share of nominal GDP offer a clear view of the government’s fiscal footprint. This ratio has ranged from a low of 17.3% in FY 2000 (during the late-1990s budget surplus era) to a high of 31.1% in FY 2020, averaging 20.9% since 1981.

A notable shift occurred after the 2008 financial crisis. From 1981 to 2007, federal spending averaged 19.8% of GDP. Post-2008, that average rose to 23.1%, reflecting structural changes in how the government allocates funds. Entitlement programs, like Social Security and Medicare, have grown significantly, driven by demographic trends and expanded benefits. These programs now account for over 60% of total spending, up from 45% in 1981.

Meanwhile, discretionary spending has shrunk from 50% to just 25%, and interest payments have climbed to around 14% of the budget, up from a historical range of 8%-10%, due to rising debt and higher interest rates. Compared to the post-WWII average of 19.5% (1947-1980), today’s spending levels reflect a larger welfare state and more active countercyclical fiscal policy.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, US Treasury, BEA

The Slowdown and Its Implications

Federal spending growth is now decelerating. In FY 2024, total outlays rose 9.98% year-over-year, reaching approximately $6.75 trillion — up from $6.13 trillion in FY 2023. This increase was driven largely by mandatory programs and surging interest payments. But in FY 2025, growth is expected to slow to just 3.75%, with outlays projected at $7.0 trillion, according to the CBO’s January 2025 baseline.

This slowdown — more than a 6% drop in spending growth — places greater pressure on the private sector to sustain economic momentum. Returning the outlays-to-GDP ratio to its long-term average of 20.9% would require cuts of 2 to 3 percentage points of GDP, or roughly $600-$900 billion annually, based on projected FY 2025 GDP of $29-$30 trillion.

The impact of such cuts depends on fiscal multipliers, which the CBO estimates range from 0.5x to 2.5x depending on the type of spending. In other words, every $1 reduction in spending could reduce GDP by $0.50 to $2.50. Historical examples include the 2013 sequestration, which shaved 0.5%-1.0% off GDP growth, and Europe’s 2010-2012 austerity measures, which prolonged economic stagnation.

 

 

 

 

 

 

 

 

 

 

 

 

Source: Sage, US Treasury

Private Sector: Time to Step Up

With federal spending growth slowing, the private sector will need to take the lead in driving expansion. That means stronger consumer spending, increased business investment, and productivity gains, particularly from AI and automation, will be essential to offset the fiscal drag.

In the near term, the strength of the labor market and consumer spending will be key indicators of whether the private sector can carry that weight. If these areas hold up, they could help sustain growth even as the government pulls back.

 

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