A Breather, Not a Reversal
After a torrid three-month run, the markets are entitled to pause. Equities bounced off their March lows and essentially went straight up, and when a market climbs at that pace, you have to expect it will eventually take a little breather. The slight pullback now visible across the major indices — some of which began turning back around almost immediately — is best understood as exactly that: a consolidation after an exceptional advance, not the start of a downturn.
Crucially, the rally that preceded this pause happened for very good reasons. That makes the digestion phase healthy rather than alarming.
An Earnings Season for the Ages
The single most important driver was an earnings season that was, in plain terms, one for the ages. Heading into it, the consensus expectation was for roughly 13% earnings growth in the S&P 500. The actual result was more than double that — about 29% growth. That is a total blowout quarter.
Beyond the headline beat, companies raised guidance and completely reset forward expectations both for this year and going into next year. The most telling signal is a rare one: prices were rising strongly even as price-to-earnings multiples were actually getting cheaper. When valuations compress while prices climb, it suggests the underlying earnings power is outrunning the stock gains — a sign of good things to come over at least the next six to twelve months.
The Stimulus Pipeline
Several forces are feeding into the economy and supporting the constructive outlook:
- AI spending is increasingly reaching out into the broader economy rather than staying concentrated, acting as a form of stimulus.
- Lower oil prices, which fell rather suddenly, are easing cost pressures. This decline is tied to the apparent pending agreement with Iran.
Iran and the Market's Love of Limbo
On the geopolitical front, the key insight is counterintuitive: the market actually likes the current state of limbo with Iran more than it would like resolution. There is a 60-day negotiation period in place, and the expectation is that it will be extended.
A final agreement is not necessarily desirable, because any final deal would almost certainly contain provisions that neither side really wants. As long as no bullets are flying — as long as the two sides simply remain in a holding pattern and extend the timeline — markets are comfortable.
The likely path is an extension that runs past the election. The political logic reinforces this: Republicans would not want a controversial finalized deal hanging around their neck. Keeping it unresolved lets them always claim the deal isn't final, so there is nothing concrete an opponent can point to. The expectation, therefore, is extension through the election, no final deal, nothing to attack — and the market will love that ambiguity.
Inflation: The One Real Risk
The single major risk to the rally is inflation. The constructive case holds together as long as inflation stays out of the way — meaning it peaks around current levels and then heads down along its disinflationary path. If that happens, the talk of rate cuts this year can be dialed back, and the last six months of the year could be very good.
The inflation picture is fragmented depending on which gauge you use:
- The PCE measure that the Fed currently favors sits at about 3.4%.
- CPI is running over 4%.
- PPI is around 6%.
- The trimmed-mean PCE measure produced by the Dallas Fed is at just 2.3%.
An important structural point: the inflation that exists isn't really the kind that rate cuts — or rate policy generally — can address. It is largely supply-side inflation, and it is being driven by wealthy consumers. That mismatch between the source of inflation and the bluntness of interest-rate tools is central to how the Fed's new leadership may behave.
Why the New Fed Chief May Be Trying Not to Move Rates
There has been a more hawkish tone from the new Fed regime under Kevin Warsh, with hawkish signals emanating from him. Yet the read here is that, despite the rhetoric, he is actually trying to avoid raising rates.
The question: How do you reach that conclusion when he sounds hawkish?
The answer lies in the awkward dynamic he occupies. He was installed by President Trump with the expectation that he would cut rates, and he himself has spent at least a year arguing that rates need to be lower. So the hawkish posture sits uneasily against both his patron's expectations and his own stated views.
The decisive clue came at the press conference. Asked whether monetary policy is still restrictive, he gave a revealing answer: it depends on what you're looking at. In some parts of the economy policy is certainly restrictive — he believes it is holding back the housing market. But in other areas, such as the financial markets, conditions are quite loose. From this he concluded that the Fed needs more surgical, tactical tools rather than relying on what he called the "blunt instrument" of overnight rates.
That signals a willingness to use other instruments in the arsenal — potentially even the balance sheet (quantitative easing and tightening), tools he has criticized in the past. The logic is to make targeted efforts: help the parts of the economy genuinely in trouble and that really need it, while declining to feed the parts where excesses are already building. Since cutting rates would only feed those excesses, and since the actual inflation is supply-side and concentrated among wealthy consumers — neither of which responds to rate cuts — a targeted approach makes sense.
The practical near-term strategy is therefore to lobby the FOMC with the message that "rate cuts aren't our answer." If he can simply get the committee to hold rates steady for the rest of the year, that would count as a success in his own mind.
Moving the Goalposts on Inflation
Looking into next year, the more ambitious play involves redefining how the Fed measures inflation. The chief favors a very different gauge — the trimmed-mean PCE from the Dallas Fed, currently at 2.3%, far below the 3.4% PCE the Fed officially tracks (and far below CPI and PPI).
The endgame may be to convince everyone that this is the better gauge of inflation. If he succeeds, then by that measure there isn't much more work to be done against inflation — in effect, the goalposts simply move, and the justification for further tightening evaporates. Whether this is genuinely his tactic remains to be seen, but it would be a clever way to declare the inflation fight largely won without additional restrictive action.
What a Switch in Metric Would Mean for Markets
The question: If he does switch to trimmed-mean PCE or another metric, how significant could that be for markets?
The answer hinges entirely on how convincing a case he can make to the bond market. This is not something he can simply switch by decree.
If the bond market concludes he is merely moving the goalposts and changing the rules to suit a predetermined conclusion, the consequences would be very bad. The long end of the yield curve would likely spike upward strongly — which would inflict even more damage on the housing market and on the consumers already in trouble. In other words, an unconvincing change would backfire precisely on the vulnerable sectors he claims to want to protect.
To change the preferred gauge of inflation and to start deploying the alternative tools he has previously criticized, he needs a genuinely successful PR campaign and a very convincing case. The credibility of the messaging, not the metric itself, is what will determine whether the strategy helps or hurts.
