Could Growth and Markets Fly?

Irrespective of whether the Federal Reserve cuts rates this week, we expect rates to fall, stimulating a reacceleration in the economy and supporting the prospects for risk assets.

While market expectations on the Federal Reserve making a quarter-point cut to rates on December 10 have flip-flopped wildly over recent weeks, what’s most important is the overall easing bias the central bank is engaged in and the constructive implications this has for the U.S. economy and risk markets.

While risks to the timing and extent of the rate cuts that the Fed undertakes remain, we don’t believe they alter the likely final destination—a lower and more accommodative fed funds rate into the second half of next year.

Such a tailwind would, in our view, help reaccelerate subdued economic growth, creating a positive undercurrent to further support risk assets over the medium term, a view we have held since at least the end of the second quarter this year.

A key factor in that view is the remarkable resilience of the economy and markets to everything they have endured in the past three quarters, strengthening the case for a more constructive—if not optimistic—outlook and inviting a reframing of the narrative from asking how we fall, to asking “but what if we fly?”

Flirting with Optimism

Although we see ample reason to remain cautious—particularly given the backlog of U.S. macro data due to the government shutdown—a Goldilocks scenario increasingly looks like the baseline with U.S. and global growth having slowed less than feared and inflation rising only modestly, which was highlighted again in last week’s benign core personal consumption expenditures price index reading.

Indeed, if there is a strong recovery by the middle of next year, as we expect, it will have been driven by several factors: further monetary easing by the Fed; forthcoming fiscal stimulus (most of the recently legislated spending cuts will not occur until after the 2026 midterm elections); robust household and corporate balance sheets; supportive financial conditions (high equity prices, low bond yields and credit spreads, and a weaker dollar); and the strong tailwinds related to extraordinary AI capital expenditure.

Furthermore, inflation may peak and then start to fall next year as the base effects of tariffs wane, and as technology-driven productivity gains potentially start to reduce costs and unlock new efficiencies more meaningfully, as we have written about before in AI: Boom? Bust? Or Both?

We believe the net result should be positive for risk markets and equities in particular—historically stocks perform strongly when the economy is not in recession and the Fed is easing—although we expect episodic bouts of market volatility along the way.

What to Watch

As we’ve flagged, there are risks to this outlook, and a policy mistake or misstep by the Fed is perhaps the risk that is currently top of mind, heightened by the clear divisions that have emerged among the members of the Federal Open Markets Committee.

Opinions are split over whether the economy needs deeper cuts to support the weakening jobs market—backed up in last week’s private sector payroll figures from ADP Research—or whether the FOMC should hold back because inflation remains above-target and tariffs could yet push it higher.

Such a divide, of course, has implications for the trajectory of monetary policy, and the neutral rate in particular. In September, the last time FOMC published projections, the 19 members had 11 different estimates ranging from 2.6% to 3.9%, the latter percent being roughly where rates are now.

Of interest will be if, and to what extent, a change in leadership at the Fed, with current chair Powell stepping down in May, will influence where the neutral rate lands. An announcement on the new Fed chair is expected in January. Although Kevin Hassett, President Trump’s economic adviser and known dove, has been seen for months by betting markets as the favorite to succeed Powell, more recent news flow on this succession suggests that Hassett might not be so much of a certainty.

How to Play It

While a policy error—either cutting too much and reigniting price pressures or cutting too little and tightening real rates into a slowdown—remains a risk, if growth remains durable, it should act as a stabilizer, reducing the odds that a miscalibration turns cyclical softness into a contraction.

The paradox is that if the Fed cuts too far, it can fuel further speculation on financial conditions, loosening the very constraints it is trying to calibrate; that puts a premium on communication and a data-dependent cadence—steps small enough to manage inflation expectations, but steady enough to prevent real-rate creep as inflation ebbs.

For markets, measured easing into higher growth is a supportive mix for risk assets. Short-rate cuts should cushion financing conditions while ongoing growth can sustain earnings momentum after the rate impulse fades—especially in equities.

In our view, by layering on a likely fiscal impulse as the administration prioritizes affordability ahead of the midterms—through lower taxes or targeted relief—the growth-and-risk asset relationship strengthens.

Overall, we see the balance of risks favoring staying invested in cyclicals and quality growth companies that benefit from both easing and activity, while remaining open to options as 2026 comes into focus.