Strong Payrolls & AI Earnings Boom Support Rate Hike Expectations

Investors entered the year expecting the Federal Reserve to cut rates twice in 2026, according to the consensus estimate in January. Nine months later, the economic reality is a stark contrast to that forecast. Friday's August payrolls report showed the U.S. economy added 162,000 jobs, nearly triple the 55,000 estimate. Upward revisions to the prior two months pushed the three-month average to 71,000 per month, a notable gain given stagnant labor force growth. The unemployment rate held at 4.1%, a level that remains stable and toward the low end of recent trends. More importantly, wage income growth is now outpacing inflation, which means real wage incomes are rising. Jobs gains were also the broadest across industries in two and a half years.

The Federal Reserve's policy rate, currently at 3.5–3.75%, sits more than 200 basis points below where each variation of the Taylor Rule (a formula for estimating the appropriate policy setting given deviations from the Fed’s inflation and employment goals) suggests it should be. That gap is a representation of the currently easy policy stance and has consequences over time. Markets have caught on and have moved to price in the adjustment, and now lean toward a rate hike for the next Federal Reserve meeting on September 16th. 

In our view, the Fed’s most prudent decision is to raise policy rates in accordance with the data. Failing to act risks the central bank’s credibility given the duration of above-target inflation and against an economic backdrop this strong. The 10-year yield has risen 60 basis points Year-to-Date, and the 30-year is up 40 bps, mostly due to higher real yields. 

BOTTOM LINE: The macroeconomic data does not give the U.S. Federal Reserve room to ease. Higher growth alongside higher rates is a difficult environment for fixed income, and we maintain our underweight to duration, particularly on the longer end.

The equity market faces a familiar balancing act this fall: strong fundamentals, set against a seasonally weak backdrop that has historically been the most volatile period of the year. Add in U.S. midterm elections and there are many potential market catalysts.

September is historically the single worst month for equities over long periods of market history, and October compounds that volatility with the highest average VIX reading for a month. In U.S. mid-term election years (with 35 Senate seats and all 435 House seats on the ballot in early November), that seasonal softness has tended to be more pronounced, as political uncertainty adds a layer of noise that markets must work through before recalibrating.

The fundamental picture, however, argues for perspective over caution. EPS growth over the trailing four quarters has exceeded 20%. Q2 2026 earnings were remarkably strong - the strongest quarter on record outside of post-recessionary rebounds - with technology accounting for more than half of that earnings expansion. That does not mean markets are immune to a pullback, as the seasonal data remains real and worth respecting. However, we see sentiment rather than a deterioration in the underlying business environment as the likely driver of potential pullbacks this fall. Any shallow dips amid this fundamental backdrop remain opportunities to add to risk, in our view.

BOTTOM LINE: We expect volatility to pick up through September and October and view any weakness as a potential opportunity given the fundamental backdrop. Waiting for perfect conditions risks missing the entry point, as dips in an environment this strong tend to be short and difficult to time.

One of the most common conversations in wealth management today centers around concentration risk, specifically that too much of a portfolio is exposed to technology and that a rotation into less correlated sectors would reduce that risk. The data suggests that approach may be both flawed and costly.

A look-through of the Russell 1000 found that 70% of companies have direct gearing to AI. That figure spans not just semiconductor manufacturers and cloud platforms, but healthcare, industrials, financials, and consumer companies - all of which are deploying AI across drug discovery, logistics optimization, fraud detection, and customer engagement. Healthcare, which investors often cite as a natural defensive diversifier when technology wobbles, shows a higher correlation to tech than many appreciate in part because technology enables a large share of modern healthcare's potential growth. For example, investors increasingly cite healthcare companies as some of the best positioned beneficiaries of AI-efficiency gains.

As such, rotating into sectors with weaker fundamentals (e.g. earnings growth) to reduce technology exposure may not reduce risk; instead, it trades one risk for another. We suggest a different approach to building portfolio ballast: commodities, industrial metals, and precious metals may offer lower correlation to equity markets and can potentially provide a hedge against the inflation and geopolitical pressures that remain present in the macroeconomic backdrop. Gold, in particular, may serve as a diversifier in a period when the traditional stock-bond relationship has been less reliable.

BOTTOM LINE: You cannot mitigate the correlation to AI by simple rotation. We prefer commodities and precious metals as potential diversifiers to complement core equity exposure, which should remain geared towards earnings growth rather than rotating into areas where fundamentals look less compelling.