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Q4 Outlook for Traders: The Fed is back in easing mode. Is this time different?
Quarterly Outlook 8 minutes to read
Summary: The beginning of Fed easing cycles are often fraught with danger, but the policy environment is like no other in modern times, with very low popular sentiment about the state of things while the market screams ever higher. We try to sort through the cloudy outlook for Q4.
It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair. – Charles Dickens, A Tale of Two Cities
Fed launches new easing amidst both the best and worst of times
Charles Dickens’ A Tale of Two Cities is a story that unfolds with the building drama of the French Revolution as its backdrop, contrasting London and Paris and the paradoxical contrasts of the intellectual ferment and great wealth among the few and great misery among many in this age. Likewise, the nominally prosperous, peak-British Empire Victorian age in which Dickens wrote was an age of contrasting wealth generation and progress and massive urban poverty. Fast-forward to our day and the always critical US economy and you would think we have the worst of times when we look at a near record low in the US University of Michigan Sentiment survey and US President Trump suffering the worst disapproval ratings of any US president in the first year of his presidency.
But look over at the stock market and you have the best of times for investors and (at least mega-cap and AI-adjacent) companies, as the aggregate stock market hit record highs in Q3 and, more importantly, record valuations. The record multiples are both relative to earnings, but perhaps even more remarkably relative to sales. Indeed, S&P 500 companies reached a stunning valuation in Q3 of more than 3.3 times sales. At the market peak in 2007, that price-to-sales ratio was just over 1.5.
At the global level, China’s markets are booming, as China encourages a domestically driven tech revolution to gain independence from and even rival the West, while European large-caps have put in a vastly superior return in USD terms than the US market, and emerging markets have likewise outperformed the US, at least in USD terms. The contrasts are stark, and the outlook is hazier than ever. Will global markets continue their ascent, enjoying further tailwinds from a fresh Fed easing cycle kicked off at the September FOMC meeting and the accompanying weaker US dollar? Or are we set for a retrenchment on a growth slowdown, as the tax-like first-round effects of tariffs accumulate and the high interest rates of the previous cycle accumulate and/or the AI capital expenditure frenzy slows?
US recession risks building further or just a tariff pig-in-a-python?
We continue to see US recession risks building, though if we fail to see the US dip into a recession in Q4, it could be down to a minor snapback in demand and activity as the trade policy uncertainty clears. Companies are also incentivised to invest by the “Big Beautiful Bill” and its 100% depreciation schedules for the year in which property and equipment are purchased. Some companies may move more determinedly now to diversify their supply chains. On the other hand, as we discuss below in the equities outlook, changes in AI-related investments could prove far larger than other capital expenditure shifts and have been a key driver of US growth this year. A couple of additional wildcards in the US: first, there is the risk of a government shutdown, where the picture is unclear as of this writing (we assume no shutdown, as it is probably impossible to gain political momentum by shutting down the government – ask DOGE).
Second and tough to measure in the medium term, especially due to very poor official data and the hazy grey-market labour data, is the impact of the Trump administration’s anti-immigration policy and degree to which this is disrupting the economy. We don’t consider the Fed’s easing policy in the growth outlook – that’s perhaps unfair, as the wealth effect is increasingly important in the US’s financialised economy. For the rest of the economy, though, Fed policy would operate on the economy with a considerable lag deep into next year.
Chart: The US Dollar Index and the benchmark US 2-year treasury yield.
The chart above shows the US 2-year treasury yield (left-hand axis for values) versus the US Dollar Index in blue. There has been a rough positive correlation between the two in recent years. With US President Trump and Treasury Secretary Bessent bent on controlling the Fed and engineering lower rates, could the two-year rate fall to 2.5% or lower by mid-next year rather than the 3.00% that was priced in late Q3 (the black dotted line is the market expectations in mid-September). A more dovish than expected Fed would support a lower US dollar unless markets are in an ugly volatile mood in Q4 and the US dollar somehow rediscovers its safe haven status. (Source: Bloomberg)
China policy urgency to support the economy will pick up in Q4.
Despite US efforts to reduce imports from China by raising higher tariff barriers than those for the rest of the world, China managed to support its economic growth with a boost in overall exports to other countries, continuing to drive its, alas, slowing growth rates. But China’s external surpluses are already grotesquely large as a percent of overall global trade imbalances and it is already clear that not just the US and Europe are wary of the impact of Chinese competition on domestic industries, but other emerging markets are waking up to the same risks from Chinese domination of production to their own domestic industries a bit lower down the value chain from EVs and AI, etc. China has always needed to rebalance its economy, and its export-driven growth model is already unsustainable in the long run. With the Chinese property bust hangover set to grind on for years to come, China will need to stimulate the consumption side of its economy and avoid a balance sheet recession by skirting deflation risks. China is caught in an ugly spot on that front – really needing a devaluation of domestic corporate, local-government and real-estate linked debt, but also needing a stronger currency if it seeks a new consumption-boosting agenda and a projection of stability and strength of its economy and currency abroad.
More urgency in Europe again?
There is now more clarity in Europe, if rather downbeat clarity, as the EU never really negotiated meaningfully with the Trump administration and basically accepted the flat 15% Trump tariff level with no retaliation for now. This seeming weakness is likely down to Europe’s concerns that retaliation would cause more disruption than submission, because it has no plan B for going on its own and is increasingly wary of China. Compounding Europe’s insecurities are its inadequacies in hard defensive deterrents to Russia, needing to keep what it can of the NATO alliance in place until it can meaningfully build up its own ability to project hard power. As Russia seems totally intransigent and unbowed in its pursuit of the war in Ukraine and even seems to be testing EU airspace with drone flyovers, Europe’s insecurities are in the driver’s seat. And within Europe, France is the new “sick man”, politically dysfunctional and prone to a run on the stability of its sovereign debt market at any time, with more than half of its sovereign bonds in foreign (and especially German hands). Plenty of urgency, in other words, but crises have to loom truly large in Europe to prompt more decisive policy action.
Anticipated market outcomes
Currencies and rates: A weaker US dollar, a stronger JPY.
We maintain a weak US dollar outlook for the remainder of the year and cyclically. Given the fiscal outlook for the US, with the “Big Beautiful Bill” cementing enormous US deficits of at least 6-7% even outside of any recession risk as far as the eye can see, US government finances can only be kept stable with lower Fed rates. The Fed policy rate is already priced to drop to 3% by mid-2026 and will inevitably be priced to get there even more quickly and beyond to 2.5% or even 2.0% in the event we do see a US recession – perhaps even with a bit of QE-on-top to help liquidity in such an event and drive the US dollar lower still.
President Trump and his sidekick Treasury Secretary Bessent have made it clear that Fed independence is on its way out – the only question is how quickly. If they can manage to get Lisa Cook fired as Trump has so far not been allowed to do, Trump can appoint another Fed governor to the board and enjoy a majority of his appointees on the board already this year before Powell steps down from the Fed Chair post next May. A wildcard for the US dollar is the status of the AI boom, with any faltering there possibly driving portfolio rebalancing away from the resurgence in favour of the US that was seen in Q3.
Among the major currencies, the most extreme valuation can be found in the Japanese yen, which traded very weakly for much of Q3 on the odd simultaneous twin developments of strong global equity markets together with concerns that sovereign bond market yields at the longest end of the yield curve risked destabilizing sovereign bond markets. Arguably, few believe that governments will allow any major dysfunction to develop in their bond markets, as they can combine with central banks to suppress yields by force at any time. But then the pressure just transfers to the currency. We assume that bond markets survive of their own accord this time around due to continued sluggish growth. This favors a repricing of the JPY much higher across the board.
We’re less enthusiastic about the euro this time around, in part on the slow-burn issue of France’s political instability and whether it can destabilize France’s debt markets. Also, the German fiscal policy impulse is bogging down in the incrementalism and a slower approach than we originally estimated. This seems to the result of “grand coalition” politics: when both sides of the centrist political spectrum are in power.
Lowest conviction: the path for equities.
In the economic outlook, we asked far more questions and provided very few answers and the same will have to go for the equity market outlook. It’s so very easy to make observations about the dominant US market trading at record multiples and expressing concerns about what can go wrong, but it’s impossible to “call the top” if indeed any major top is within sight in the coming quarter. Any significant setback in the Mag7-heavy US market would inevitably involve AI. And we’ve no idea whether the AI investment boom can accelerate for another quarter or two or even more. Still, we suspect that we are nearing the end of the beginning of the AI investment cycle, given the scale that spending has reached, the lack of strong evidence for a solid return on invested capital (ROIC) and the seeming lack of major advances in the quality of the latest models. Zooming out to the global level, we’re somewhat more constructive on Europe, and in emerging markets, the weak US dollar is an ongoing boon, though weaker growth scenarios tend to cause a choppier environment for asset prices.
Commodities: Enjoying a weak USD tailwind.
Gold has surged nearly 40% this year, putting it on track for its strongest annual rally since 1979, when the global energy crisis triggered an inflationary shock. Today’s gains, echoed in silver and platinum, reflect broad investor unease about the global economy — particularly the U.S. and its growing debt burden.
We maintain a bullish long-term view on gold and see further upside for several reasons. A softer dollar and lower funding costs, as the FOMC moves into a second round of rate cuts, should underpin investor demand. ETF inflows in 2025 have already surpassed the combined outflows of the past two years, underscoring renewed interest.
A potential headwind is a slowdown in central bank purchases as the value of their gold reserves climbs relative to other assets. Still, this may be outweighed by a more powerful driver: the risk of eroding Fed independence. The fear of political interference and control could see inflation expectations become unanchored and fiscal sustainability questioned. A scenario that could see gold extend well beyond our near-term USD 4,000 target.
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The instrument(s) mentioned in this content may be issued by a partner, from which Saxo receives promotion, payment or retrocessions. While Saxo receives compensation from these partnerships, all content is conducted with the intention of providing clients with valuable options and information.