Fed Chair Powell’s Jackson Hole speech signalled a dovish tilt, opening the door to a September rate cut. The Fed is under pressure to balance unemployment and inflation risks, with the FOMC split between doves and hawks. Recent data have not resolved the divide: Doves were emboldened by the weak July jobs report with downward revisions to previous months, while hawks saw validation in hot CPI and PPI prints.
Powell’s speech focused on the outlook and the Fed’s framework review, but markets reacted to his emphasis on the shifting balance of risks toward unemployment. He downplayed the risk of an inflation spiral, stressing that the labor market is losing momentum and not overheating, and that inflation expectations remain well anchored. Investors interpreted this as a willingness to look through transitory inflation risks, tipping the balance toward the doves.
- Inflation Will Be Transitory
- Another Powell Mistake?
- Meaningful Monetary Easing Over the Next 12 Months
- Europe is Still Attractive
- Fiscal Austerity Is Gone
- Has The U.S. Dollar Entered a Bear Market?
- Geopolitical Risk: American Sanctions
- An Attractive Defensive Play
- No More Involution
- Our Portfolio Positioning
Inflation Will Be Transitory
Long-term inflation pressures are likely to remain limited. Leading indicators point to higher near-term inflation due to tariffs, but lower inflation on a 12-month basis. The US economy and labor market are not overheating, limiting firms’ need to pass on higher costs.
A lot will depend on what the CPI and other price measures say about who is paying for the tariffs, and what the unemployment rate says about fewer immigrants entering the labor force and the pace of hiring. We believe consumers are shouldering the majority of the cost of tariffs, as evidenced by weaker wage growth compared to higher inflation. Real hourly wage rates grew at 1.3% in 2023 & 2024, similar to the pace from 2017-2019. That roughly matched productivity growth, so unit labor costs were steady, and profit margins were strong but stable.
We are in the camp that any inflation caused by tariffs will be transitory this time. And the Fed should start cutting rates. Given the recent weakness in the job market, the Fed might even be late already.
What about tariffs and rising prices? What we need to realise that tariffs are consumption taxes. President Trump has effectively introduced a consumption tax, quite an unexpected outcome given his supposed economic populism. The One Big Beautiful Bill Act (OBBBA) only has around $664 billion of new tax cuts over the next decade, but tariff revenue is now estimated to raise around $2.7 trillion over the same time period. Do you see what Trump did there?
With fiscal stimulus stalled and new consumption taxes hitting the US consumer, any increase in prices will be temporary.
The reason that inflation was most definitely not transitory in 2021 is that fiscal stimulus ensured that high goods and services prices were, in fact, sustainable. But note that it required an epic amount of stimulus to ensure that outcome. Today, there is nothing close to the 2020-2023 level of stimulus available to offset the increasing cost of tariffs. Real wages are still positive, but consumer sentiment is negative, suggesting that consumers may curtail spending on leisure, accommodation, and restaurants, to pay higher prices of imported goods. That is a recipe for an economic slowdown, one way or another.
Another Powell Mistake?
We are, therefore, surprised that the Fed Chair Jay Powell continues to reference tariffs and trade uncertainty as a reason for not cutting interest rates. If he wants to prove that he and the Fed are independent, he is likely to make a big mistake.
In fact, we find ourselves agreeing with President Trump’s macroeconomic assessment that interest rates are too high. Other central bankers around the world agree with the President. Which begs the question of what Fed Chair Powell is thinking. It seems he is cautious to call inflation risks transitory because of the massive misjudgement he made in 2021.
If the Fed will not start cutting rates in September and indicate a new rate cutting cycle lies ahead, Powell may well be making a policy error. While geopolitics and demographics remain tailwinds to structural inflation, they are slow-moving factors. The economy is clearly slowing down while politics, specifically, fiscal policy, is no longer providing the kind of support that ensured that Powell would be disastrously wrong in 2021, when he characterized price increases as transitory. Fiscal support is gone, which means that any move higher in prices due to tariffs will be inflationary in the short term, but disinflationary on a 12-month basis. Chair Powell is going to come to terms with this reality.
The other side of the coin is that Trump now effectively has established Powell as the scapegoat for any economic weakening over the next several months, when tariffs hold the greatest risk to both growth and inflation. The 25-point cut in rates that is currently expected for September will not change that reality, as Trump has called for 300 basis points of easing, and Bessent recommends 50 in September and 150-175 as soon as possible. Anything less and all weakness is due to Powell’s stubbornness until a new Fed boss is appointed by Trump to save the economy, just ahead of the mid-term elections. If the economy is doing well, that was despite Powell, and he is wrong on policy no matter what happens.
Meaningful Monetary Easing Over the Next 12 Months
What does this mean for investors? It means that the Fed will turn dovish at a time when fiscal stimulus has ended. This is likely bearish for the dollar, but not necessarily for bonds or equity markets. From a macro perspective, a dovish Fed, end of fiscal stimulus, and a slowing economy are positive for stocks and bonds.
Even if a further economic slowdown raises the risk of a shallow recession, however, it is also possible that the economy slows but avoids recession if monetary policy is eased sufficiently, as it would support further capital investment and a potential rebound in the housing market.
We do not see the tariffs as a threat to continuing US economic growth, which seems to be running in the high 4% range for nominal GDP. The second quarter GDP was adjusted up by 0.3%, to 3.3%, and the Atlanta Fed’s GDPNow soared to 3.5% for the third quarter. That leaves real GDP growth averaging 2.1% so far in 2025. Add in mid-2% inflation, and you are around 4.7% for nominal GDP, down a tad from the pace of 2024. Profits, the key leading indicator for a capitalist economy, remain at historically high levels, providing plenty of cushion for firms to absorb unexpected shocks without resorting to layoffs. Yes, a lot has happened, but businesses have not panicked. CEOs become more comfortable with the new rules and plan ahead for continued growth in 2026.
We remain constructive on global equities despite the clear economic slowdown. Less fiscal stimulus, dovish monetary policy, and a slowing economy should bring yields down and help equities amidst the ongoing AI capital investment boom.
Europe is Still Attractive
The outlook for European equities is becoming more appealing relative to U.S. equities. Many structural headwinds are fading in Europe, and valuations remain historically low. European equities are still quite a bit cheaper than U.S. ones across all sectors. The private sector’s debt load stands at its lowest level in 17 years, and European banks are now in a position of strength.
Helped by President Trump’s tariff war and pressure on NATO, we are seeing a deeper fiscal and financial integration happening in Europe, which will be a tailwind for European equities. European fiscal policy is becoming more accommodative, including significantly more spending on defense and infrastructure, especially at a time when the U.S. is forced to balance its fiscal spending.
Since 2007, European equities have underperformed American stocks by 220%. Year-to-date, the relative outperformance amounts to 3% in local-currency terms, but 16% in USD terms. Several factors have led investors to warm up to European equities. First, lofty economic growth expectations in the U.S. disappointed, unlike in the Eurozone, which surprised to the upside. The €1,000 billion stimulus package announced by Germany lifted growth expectations for the bloc and supported investors’ optimism toward Europe.
While the U.S. equity market has rebounded over the last 3 months, propelled by Nvidia and Microsoft, European outperformance is likely not over, and Europe remains a compelling investment destination for investors. Admittedly, European equities have been cheap compared to U.S. ones for a very long time, which did nothing to stop the structural underperformance of past decades.
In the current context, however, the valuation gap really matters. Cheap European equities offer more protection against adverse shocks than U.S. stocks do, at a time of heightened concentration risk. The additional risk factor is that we are seeing rising concentration in the market driven by one factor: Artificial Intelligence. Nvidia and Microsoft account for almost half of the S&P 500 returns this year, as opposed to a much broader rally in European equity markets.
Fiscal Austerity Is Gone
The winds of change are blowing. The succession of crises in recent years, the pandemic, war in Ukraine, energy crisis, and more recently the trade tensions with the U.S. has highlighted the necessity for more fiscal spending, both at the country and EU level. Germany is spearheading this fiscal shift. Chancellor Friedrich Merz has lifted the debt brake and embarked on a €1,000 billion spending spree focused on defense and infrastructure, a stark contrast to the fiscally conservative stance of his predecessors. While European fiscal policy becomes moderately more accommodative, the U.S. is abandoning its massive fiscal stimulus packages of the past 9 years.
President Trump’s One Big Beautiful Bill Act (OBBBA) combined with the tariff hikes will create a fiscal drag. For the remainder of the decade, the U.S. fiscal stimulus will be much smaller than it was from 2016 to 2024, turning from a tailwind into a headwind. This change in relative fiscal stance is also positive for the performance of European stocks relative to U.S. ones since fiscal differentials affect real economic growth and returns on invested capital.
European banks have greatly rebuilt their balance sheets. Nonperforming loans are no longer a threat, capital and liquidity ratios are robust, and profitability has improved. This explains European banks’ outperformance since 2022. Considering banks dominate European lending, accounting for 70% of firms’ borrowing compared to 25% in the US, a healthier banking sector will help European growth improve and will support capital investment.
Has The U.S. Dollar Entered a Bear Market?
The U.S. dollar is down by 12% versus the euro since the start of the year. While a pause is likely in the near term, the dollar bear market is just starting. The U.S. depends on foreign capital to fund its deficits, but rising policy risk, smaller economic growth differentials, and the repeated attacks on the Federal Reserve’s independence are also weakening the dollar.
Meanwhile, structural reforms, deeper integration, and improved capital markets strengthen the euro’s long-term appeal. The longer-term trend remains higher, toward 1.40 over the coming years.
It might initially seem counterintuitive that a stronger EUR/USD is also a reason to favor European stocks, since a stronger Euro hurts the profitability of European large caps that derive a large share of revenues abroad. However, within the context of a global portfolio, a stronger EUR/USD means that the currency return enhances the performance of European stocks held by investors in the U.S.
Geopolitical Risk: American Sanctions
Russia has made a mockery of President Trump’s policy on Ukraine and his attempts to broker a peace a deal. President Trump thought that he illustrated to Putin that he was objective and capable of delivering a deal that was fair to Moscow. Putin completely ignored it, daring him to prove that the U.S. is credible. There is a high likelihood Trump will do that. And Russia will pay the price for that. This is a serious risk that it could unsettle markets in short-term.
Despite the recent show of camaraderie between the Presidents of China, India and Russia, they are not going to help Russia.
China, India, and Turkey import 73% of Russian total 4.2mb/d of exported crude. Neither of the three would want to have 100% tariffs applied against them. Not to mention that the U.S. could pursue a varying strategy of applying pressure beyond just higher tariffs on its own imports. It could, as the Obama administration did when it applied secondary sanctions against Iran, go after the foreign corporations that are buying Russian crude.
And Europe will likely tag along with similar sanctions, which means that any bank in the world that trades USD or EUR, would need to close all accounts of sanctioned companies. Or companies that have any trade with Europe or the U.S. would no longer be able to deal with Russia. The economic side effects for other countries, like Thailand, could also be quite negative.
In the case of an escalation, oil prices will likely shoot up, at least initially. OPEC has already gone ahead by announcing another production increase. The fact that Russian oil exports are important, but not critical, would allow Trump to put pressure on Moscow. In the event of significant secondary sanctions, oil prices will likely rise, and the impact on global market sentiment is going to be negative but also likely to be short-lived.
The upside of sanctions is that a potential peace deal between Ukraine and Russia would become more likely in the coming months, which would be supportive for market sentiment.
An Attractive Defensive Play
Over the past decade, the healthcare sector has encountered a range of significant challenges, leading it to lag well behind the broader U.S. stock market. While the S&P 500 index has been on an impressive run over the last decade, averaging a return of 11.9%, the S&P 500 healthcare sector has managed to deliver less than half that amount, coming in at 5.8% over the decade. The underperformance this year can be attributed to large amounts of regulatory uncertainty.
The recent period of underperformance may represent an attractive entry point. The significant valuation gap between healthcare and other market sectors offers a favorable entry point for investors. As regulatory uncertainty recedes, companies in this space are likely to benefit from improved sentiment, as current valuations reflect pessimistic scenarios that are unlikely. In addition, emerging technologies, including artificial intelligence and advanced robotics, are poised to enhance drug discovery and facilitate new medical procedures.
Next that, the One Big Beautiful Bill Act (OBBBA) allows companies to write off R&D expenses against their tax bill immediately, instead of amortizing these over many years. This provision is especially beneficial for healthcare companies, who have significant R&D cost and should boost corporate earnings.
The ageing population in the United States, Europe, Japan and China is expected to drive continued growth in healthcare expenditure. Given the defensive attributes and the comparatively attractive valuations, we favor the healthcare sector as a portfolio diversifier.
No More Involution
“Involution” is the latest buzzword in commentary on China’s economy. It refers to excessive and self-defeating competition among Chinese companies for limited resources and opportunities. This has fuelled overproduction, price wars, and deflation. In July 2025, President Xi elevated the issue at the Central Financial and Economic Affairs Commission (CFEAC), marking “anti-involution” as a national priority. Since then, Beijing has introduced more than 50 measures across industries, from solar and EV batteries to cement and e-commerce, to curb excessive competition and encourage more rational supply discipline. The key question is whether this campaign can improve profits and bolster China’s growth.
There are reasons to be optimistic. A recent Goldman Sachs report estimates that every 1% rise in producer prices could lift profits by 2%. Additionally, in industries most affected by involution, normalized margins could drive profit growth by 53% by 2027 and contribute up to 14% to overall market earnings. Unlike past overcapacity crackdowns, today’s campaign benefits from stronger political backing, more precise cross-ministry coordination, and a focus on strategic sectors, increasing the likelihood of lasting impact. Recent market moves have been encouraging, with ‘anti-involution’ sectors, such as solar and steel, outperforming the benchmark MSCI China Index since July.
While demand-side support will remain necessary, the campaign addresses one of the biggest drags on China’s earnings cycle by reducing excess supply and promoting rational competition. With valuations still undemanding with the forward P/E of MSCI China at 13.5x, versus 24.4x for S&P 500, and room for more stimulus measures, the case for maintaining an overweight allocation to China remains intact.
Our Portfolio Positioning
The summer months turned out to be remarkably calm and positive for equity markets. September and October are traditionally more volatile months, but as listed above, risks can both be positive and negative.
In stocks, we remain slightly defensively positioned for the coming months as we expect markets to be volatile and prone to swings, but ultimately positive. We keep overweight positions in healthcare, commodities, European, and Chinese equities to create a diversified portfolio that can profit in different market circumstances.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The Consumer Price Index (CPI) is a measure of inflation compiled by the US Bureau of Labor Studies.
The Producer Price Index (PPI) is a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time. PPIs measure price change from the perspective of the seller.
The S&P 500 Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance.
The MSCI China Index captures large and mid-cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). With 738 constituents, the index covers about 85% of this China equity universe. Currently, the index includes Large Cap A and Mid Cap A shares represented at 20% of their free float adjusted market capitalization.
Asset Allocation does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
