Charting the course: Macro and markets in Q4

BRIAN HESS: Hello, everyone. Welcome to our third quarter macro webinar as we look ahead to the final stretch of 2025. I'm Brian Hess, portfolio manager on the Solutions team at Natixis. And joining me today are Jack Janasiewicz and Garrett Melson. As a reminder, Jack is multi-asset portfolio manager and lead portfolio strategist for Natixis. Garrett is a portfolio strategist as well and member of the Natixis Investment Committee.

Now, Garrett, we're going to start with you today. Last week, the US Federal Reserve cut interest rates for the first time since last year. So they went on a long pause, but decided to resume that rate cutting cycle.

Labor market weakness was a big part of the reason why they decided to take that step last week. So I think to start, it would be good if we could update everyone on our views regarding the US labor market and what's been behind the very slow job creation since April.

GARRETT MELSON: Yeah, well, I think the framing is spot-on. That certainly is what the Fed's worried about, or I guess I should say, some members of the Fed are worried about those downside risks to the labor market. I'd say followers of our work know well that we've been cautioning about the downside risks there for quite some time.

Generally, all year last year, I think, the weakening or the softening in labor markets was a little bit more benign in nature. It was really driven by a pretty significant influx of labor supply, so entrance and re-entrants coming off the sidelines. Immigration is certainly a part of the story there.

But it certainly has been a shift this year. I think the narrative has certainly caught up to the idea that the labor market is maybe no longer solid, like the Feds claimed for much of this year. And even the Fed's thrown in the towel there. And I think that's a clear recognition by most market participants in the Fed that labor markets are somewhat soft.

Now, there is certainly varying debate in terms of how weak it is. And I think that actually opens up an interesting point, which is what I really want to focus on, which is this idea that there are some corners of the market that really blame a lot of the softening and the slowdown in the labor market really on a slowdown in labor supply.

And it's part of this story, but as we walk through the next couple of slides here, I want to really focus in on what I think is the bigger issue, which is still the demand side of the equation in here. So it's an interesting debate. And supply is absolutely adding some nuances in here, but certainly, from our perspective, the labor market is cooling down.

Demand is the bigger driver here. And that just suggests that there are still some pretty material downside risks, which fortunately, the Fed is starting to look a lot more closely on and look past some of the risks on the other side of the dual mandate here.

So just to set the stage with the first slide here, where we've been and where we are today, the unemployment rate-- I think part of the story around this idea that labor markets were solid is the fact that we had seen the unemployment rate tick pretty steadily higher here, looking at just the U3 in light blue versus the three-month average, just to smooth through some of the noise.

And we've seen some pretty steady weakening and a tick higher through much of 2024. And then it stabilized, really, for much of the last year or so, but I think that misses some of the nuance and the fact that we had a stabilization late last year, but basically, since January, we've been back on a steady grind higher here.

So it's pretty clear that after a little bit of a breather, the unemployment rate is on a sure but steady move to the upside here. So that gets into the story of what's really behind that. And I think the labor supply story is interesting. And that's part of why you saw a lot of that move higher late, or I guess, in the middle of 2024, is basically a function of increasing workers coming off the sidelines, whether they're new entrants, or re-entrants, or immigrants, was basically meeting a wall of low hiring rates.

And that just meant that new entrants into the labor force were piling up in the ranks of the unemployed. Not great, but certainly not all that concerning. And that's why I think it's a little bit more benign in nature, but if you look at labor supply or labor force growth here in this next slide, you can see we've moved from an environment basically of 1.5% to 2% annual growth in the labor force, which is obviously pretty important as a key driver of demographics and a key driver of economic growth-- but basically, since the middle of last year, we actually saw the Biden administration start to lock down on border policy.

That's obviously continued into this year, with the administration's focus on immigration. And as a result, labor force growth has basically ground to a halt. It's basically moved sideways for the entirety of this year. So that dynamic is completely flipped.

And I think some of the bulls on the labor market side would say that well, basically, that just means that labor supply and labor demand have moved lower. So we're still somewhat in balance. And that just means that the unemployment rate is probably going to remain somewhat well-behaved in here.

I think that's a little bit of a misread of the situation here because 1, stagnant labor force growth isn't great. That's going to be a key driver of economic growth. So to the sense that that's really pushing down your break-even rate, a payrolls growth, that's the reason why we're seeing some really tepid levels of headline payroll employment gains.

That's not great in the sense that it means that income growth for consumers is probably slowing down here. So there are some downsides from that, but I think the bigger story is it's somewhat obscuring the fact that there's maybe a little bit more concerning slowing going on in the labor market when you start to dig into and pull back some of the layers under the surface, the first one being for all this focus on immigration, immigration doesn't explain the fact that on this next slide, take a look at what unemployment has done for college-educated workers.

You're ticking up to new cycle highs here. Basically, back to levels, excluding the pandemic, that we haven't seen since 2017. This is a pretty similar chart if you just look at native-born workers. So strip out all the noise about immigration and just focus on native-born workers. Same story.

You've seen basically that unemployment rate tick up to cycle highs. And again, back to basically 2017, early 2017 levels here. So immigration is part of the story when you look at the overall picture, and certainly, when you look at the slowdown in nonfarm payrolls, but it's not really explaining the easing and the cooling that we're seeing in some of these other ratios.

Looking at, really, what the issue is, it's labor demand. And on the next slide, one way to look at that is just simply look at the number of job openings from the JOLTS survey relative to the number of unemployed workers here. That ratio is finally compressed back down to basically the equilibrium. Actually, just inside it.

So what does that mean? It means that we actually have more jobs than we have unemployed workers. And again, when you start thinking about labor supply, another reason that's maybe hampering labor supply is the fact that in a low hiring rate environment, you're seeing more and more discouraged workers. And that means that you're actually seeing an increase in the number of workers that are no longer in the labor force that might actually want work. So that actually might be understating the level of unemployment here.

So I think what puts this all into context is if it's really all about labor supply, well, then why is wage growth continuing to soften upward in here? I think that's really the biggest hole in the argument is that if labor supply and labor demand are falling in unison, well, that suggests that the labor market is somewhat in equilibrium, somewhat still in balance, and maybe that means that wage growth should not be easing.

But wage growth is cooling. If you take a look at a broad measure here, whether that's ECI-- the Atlanta Fed has their wage tracker that's better comparing one-for-one across time, average hourly earnings, whatever you're looking at, they're all continuing to grind lower.

And I think the biggest one to keep an eye on, the Indeed posted wage growth-- that's for new job listings. That's actually starting to accelerate to the downside in here. So from a point of basically normalized wage growth, we're actually continuing to see some downside and some cooling in here.

That, to me, suggests that this is not a labor market that's in this curious equilibrium, as Powell likes to say. It's one that outright is continuing to see slack build in here. So just to put this all into context, I think there are still some risks to the labor market. And there's some risks that, because of some of the labor noise around supply, we might actually be understating the amount of slack that's in the labor market.

And one way to put this into context-- it's actually a couple of different charts. This is how you peel back the layers. This is a composition of four different indicators that I think get at measures of slack in the economy, the first one being the conference board's labor differentials. So basically, are consumers seeing jobs easy to get versus hard to find?

The NFIB, the Small Business Survey, asked businesses, what's your single biggest problem? And we're looking at the proportion of respondents saying that poor sales are their biggest issue. Poor sales are a problem. That means that you're probably going to be focusing pretty closely in on employment.

And the last two are the Atlanta Fed's zero wage growth. So how many workers are actually seeing outright flat wage growth? That continues to creep up to a new cycle high. That's one of the first levers that employers are going to pull before actually reducing headcount.

And finally, I mentioned the labor supply around discouraged workers. The last one would be people not in the labor force, but want work. That's also ticked up to a new cycle high. So if you put all those together and z-score them to look at where they sit relative to their average, they're all ticking up to new cycle highs in this aggregate measure in the light blue line.

And no surprise that those tend to track pretty closely with the unemployment rate. So I think in here, 1, labor supply really is a sideshow. The cooling is about labor demand. And when you pull back the layers here, to me, it suggests that some of the supply might be distorting the labor dynamics and figures that we're looking at. And there might actually be a little bit more slack in the economy and a little bit more slack in labor markets than meets the eye at first blush.

BRIAN HESS: So Garrett, it seems like most measures of the labor market are still deteriorating, and in some cases, are at very sluggish or even approaching borderline recessionary levels. Is there a degree of job creation or maybe even job loss that would get you more concerned about the labor market moving from a slowdown phase to one where we start to see a nonlinear rise in the unemployment rate, or just a big weight onto consumption in the economy?

GARRETT MELSON: Yeah, for now, one of the key measures we look at is aggregate incomes. So take the number of people that have a job, multiply that by average hourly earnings, multiply that by their average hours of work per week. And that gives you a sense of what the spending power is doing in terms of growth for the consumer.

And it's income that tends to drive consumption in here. That continues to hold up OK on a three-month basis. Annualized, it certainly has slowed down, but it's not to the point where we're too concerned just yet. I think the issue here is that payroll growth has slowed down quite dramatically. Unemployment continues to grind higher in here.

And that means in a low fire, low hire environment, it doesn't take much in the way of increased layoffs to actually drive a much more material increase in the unemployment rate. So that's something that I think we need to keep an eye on. For now, that remains at bay. And so it's just a story of a slowly cooling labor market, but one that continues to have downside risks that the Fed needs to be attuned to.

BRIAN HESS: So initial jobless claims, key to watch. And we're keeping an eye on our household paycheck proxy, which remains positive, but were that to move into negative territory, then we'd have some real concerns.

GARRETT MELSON: Exactly.

BRIAN HESS: Now, given what you just showed for the labor market, I think it's reasonable to believe the Fed may have moved on rates a bit sooner this year, were it not for the tariffs and their concern about potential inflationary results from those tariffs.

So I think now that we've had them in place for a few months, we've gotten some CPI reports, some PPI reports, can we talk about whether or not there's convincing evidence that tariffs are pushing inflation higher, or maybe catalyzing another leg up in the inflation readings?

GARRETT MELSON: Yeah. So I think it's been encouraging. If you look at the labor side of the mandate, I'd say there's reasons to be cautious, but on the price side of the mandate, there's reasons to be a little bit more encouraged because we have seen a fairly limited pass-through.

To borrow from Powell, it's been smaller and slower than expected. And I think that's encouraging. And from the Fed's perspective, that just means that they're starting to grow a little bit more confident that these price effects from tariffs are not going to morph into a more persistent problem that requires policy action.

To your point, it certainly has been, I think, a barrier to them easing earlier this year, but they're starting to get more confidence around that as some of those downside risks to unemployment start to creep higher here. So that allows them and gives them the cover to really focus more on the labor side of the mandate.

When you start peeling back the layers, again, under the surface, can clearly see signs of tariffs. On the first chart, we're just looking at some of the most tariff-sensitive line items within the consumption basket. And no surprise there. It's generally consumer goods here.

So the purple line is just looking at a basket of consumer electronics. And then we expand that a little more broadly in the light blue to look at just broad consumer goods. So think television, cell phones, furniture, appliances, toys. The list goes on, but it's the usual suspects that you would expect.

And the story here really isn't one of a significant move higher in the aggregate price level. It's more so just a deviation versus the pretariff trend. And by that, I mean you can see the lines. The solid lines are the actual price levels. The dotted lines are the pretariff trends.

So we're just basically moving into this environment where the price level is basically plateaued as opposed to continuing to deflate. So that's been the bigger story here. And if you just zoom in on this and scale that to the contribution to core CPI on the next slide, you can see it's just not really moving the needle all that much at the aggregate level.

All those line items-- they only add up to about 6%, maybe 7% of the core basket. So yes, you're starting to see some tariff effects. And you have, really, for the majority of this year, but at the peak, really, that June print-- it wasn't even adding 5 basis points. And since that, the last two prints have been even a little bit more tepid in here.

So yes, there are some signs that you're seeing pass-through. And that is helping to keep inflation maybe not from surging, but maybe keeping it a little bit stickier than it otherwise may have been, but it has been a thorn in the side for the Fed to the extent that they're worried that what looks to be a one-off might morph into something a little bit more persistent.

What I think is interesting, though, is still maybe a little bit early to call exactly how this is going to play out. And by that, I mean, on the next slide, there's some signs that consumers are paying it, but there's also some signs that businesses are paying and shouldering that burden.

This slide is just looking at the PPI measure. And one thing, a public service announcement-- PPI doesn't really measure what you think it does. It's not really measuring producer prices explicitly, but one line item there is this concept of trade services.

Basically, that measures margins for retailers. So it's going to look at what their costs are versus what their selling prices are. And you can see we've actually gotten, in the latest print in August, a pretty sharp move lower here. And that actually suggests that margins are compressing. And it would suggest that maybe you're seeing a little bit of absorption of tariffs through businesses.

It certainly doesn't look like foreign suppliers are shouldering that burden, given the fact that the dollar is weaker and import prices are stable to maybe even a little bit higher. So it really does boil down to sharing that burden across supply chains as well as the consumer, to some degree.

But the bottom line is it's been smaller than feared. It's been slower than feared. Maybe that takes a little bit longer, and it's a lower peak and a longer plateau of that effects, but I think the bottom line is boil that back down to the policy implications. The Fed is growing more confident that this is simply not going to morph into a persistent inflation problem.

And I think the biggest reason to be optimistic on that is the fact that if the labor market is slowing, that means that consumers don't really have the ability to absorb significant price increases. And they're losing leverage with respect to their employers. So they're not going to be able to ask for significant wage increases. That all limits the likelihood that this morphs into a persistent problem. And that's exactly why I think you're starting to see the Fed move towards and focus more on that labor side of the mandate.

BRIAN HESS: So it sounds like there's some evidence of the tariffs showing up in the price indices, but it's just not big enough magnitude right now to really cause major concern for us as investors or for the Fed as policymakers. And the important thing to remember-- since inflation is measured as a rate of change, the further we get away from the tariffs being implemented, so nine months from now, when they've been in place for a year, that marginal impact should be even less. So if we can get through the next six to nine months without material inflation, it seems like we'll have been able to put up these tariffs and not have paid a major price on the inflation front.

Now, Jack, let's bring you into the conversation. And we've mentioned the Fed restarting the rate cutting cycle. It was a big meeting last week. Garrett highlighted the labor market and the inflation trends. We've got a lot of background we've established. So maybe it's a good time for you to come in and give your impression of the Fed meeting, the dot plot, the press conference, and what you saw as the key takeaways.

JACK JANASIEWICZ: Yeah. And I think there's certainly plenty of things that can be gleaned here. And maybe it's worth starting right off the bat, just giving a little bit of a summary in terms of our takeaways here-- and I think the first big one from our perspective is simply that the Powell put, I think, is still in play here.

And what does that mean? Well, that left tail downside risk to growth, I think, gets clipped a little bit on the back of this, but it's certainly not completely gone. But again, I think it's been clipped a little bit. And while I think the market has started to price in a consecutive rate cut cycle going forward, I think we'd rather say that the Fed is dovish, but maybe conditionally dovish.

What does that also imply? Well, the Fed is probably going to be a little bit more reactive as opposed to being proactive. And the risk, again, to being reactive is simply that if we start to see that linear cooling in the labor market start to accelerate to something more persistent, the market probably would then start to assume that the Fed might be behind the curve.

And obviously, that would be a potential concern for risk assets and volatility. So that's one of the things to keep thinking about going forward here, but also, keep in mind that if we do get persistent labor market weakness, that probably does put downside pressure on prices, as any job market weakness is certainly going to be putting some downside pressure on prices as nominal wages continue to cool.

So that buying power, that consumption power continues to ease off a bit, but in general, I think the bigger takeaway for us-- what does this mean for the markets? Again, the equity markets, I think, believe that the left-tail growth downside risk is certainly not quite to be as significant as it had been because of that Powell put.

The fixed income market, I think, is also in agreement there, but also, I think justifies itself in thinking that growth is potentially weaker. And as a result, you get that rally in rates. And I think put this all together, and what does that tell us? Well, it probably means that investors might be at a bigger risk of simply missing a push higher as opposed to a pullback in the market.

And so I think that's the key going forward here for how we're thinking about things. If we go to what the Fed has been really talking about-- and Garrett's walked through a little bit of this-- but it's the idea that the balance of risks from the Fed have clearly shifted.

The labor market side of the mandate is much bigger than the price stability side. And basically, what you're looking at here is that risk weighting chart that the Fed puts together-- basically, the individual members say which is their biggest concerns here.

And you can see we're getting a little bit of a deviation where that purple line, which is the inflation backdrop, certainly moving lower. And we've got a little bit of an uptick in the unemployment rate. So this is implying that the Fed is becoming a little bit more in tune with the labor side of the mandate relative to the price stability side. So that's the shift that we've seen here.

But while we certainly are focusing a little bit more on the labor side of the mandate, I still think there's two-sided risks here. Those haven't gone away. The risks, I think, are still that inflation remains sticky, remains elevated. And at the same time, well, we do get a little bit of a softening in the labor market.

So against that backdrop, I don't think everything has gone away, so to speak, but again, if we start to use some quotes from what the Fed statement said, one of the things that was removed in this statement relative to the last statement was simply that labor market conditions remain solid. That was stricken.

So I that puts more emphasis on the idea that that labor market concern is moving front and center. They came out and explicitly said that the downside risks to employment have risen. So again, highlighting that same backdrop. And then the last thing that worth pointing out here is simply that Powell made the comment that there is no risk-free path.

And I think that's key here because it still gives us the idea that the Fed is data-dependent going forward. And again, back to that risk that I had spoken about earlier, again, if we get an accelerated slowing in the labor market, there's a potential that with the Fed being reactive, the market interprets that as the Fed being behind the curve. So that's, I think, our takeaway with regard to the Fed backdrop here.

What I thought was interesting-- Powell made the comment talking about this being a risk management cut. And when you think about where the Fed is, they're certainly restrictive. Making this cut as a risk management cut simply just makes them less restrictive.

And one of the ways that we like to define whether the Fed really is restrictive or not-- you're just simply looking at here these are wage and salary disbursements. That growth rate in purple-- and we're overlaying that on top of the Fed funds rate. And so when the Fed fund rate actually starts to move above that wage growth backdrop, that's implicitly saying that credit conditions are maybe marginally tighter.

And as a result, you could imply that the Fed is being restrictive. And so that insurance cut, that risk management cut, at least moves it a little bit lower, keeping it in lock step. And I think that gives the Fed a little bit more wiggle room here going forward. So that risk management cut, I think, is very interesting.

But take us to the dot plot here. And again, just to highlight what we're looking at, those purple dots-- that's where we were last meeting, last June. The light blue dots-- that's where we currently are. And then you can see the path of that median dot delineated by the line chart that's in there.

And there's a couple of things that I think are worth highlighting. And again, take it with a little bit of a grain of salt because Powell did try to downplay the dots, to an extent. He had some comments in his presser afterwards saying it's not obvious what we should be doing going forward here.

And I think that highlights the idea that there's still plenty of uncertainty and lack of conviction within the Fed. And I think we certainly see that within the dot plot here. So a couple of things, I think, worth highlighting. First of all, if you look at the 2025 dots, 10 officials saw at least 2 more cuts by the end of the year, while 9 just saw 1 or fewer cuts.

And certainly, you can see the big descent there way down the bottom. I think most people can expect that to be Steven Myron. And I think what's worth noting here is that there's been a lot of concern about Fed independence. And I think this was the chance for both Waller and Bowman to, if they really wanted to, go along the lines of what Trump has been asking. You would have seen, I think, a bigger move down in terms of those dissenting dots.

And you didn't see that. So maybe, I think, you could put some of that Fed independence concerns behind us based on that dot plot, but if you also look at 2026, there's a pretty wide dispersion in the dots here. And again, more evidence that there's less conviction and consensus across the board in terms of what they expect the path going forward to be.

And then 2027-- sure, that path of the median dots is moving lower by one cut, but take it out even farther, and look at that very far right column, that long-term forecast, if you will, that long-term neutral rate. That range is pretty wide. We're going somewhere from between 2 and 5/8 all the way up to 3 and 7/8.

So again, I think the highlight here is simply that there's a lack of conviction and plenty of uncertainty with regard to the Fed. And they're going to continue to take it as it comes in terms of that data backdrop. So certainly, I think the risk may be going forward.

And again, looking at that line plot, which is basically showing the evolution of the SOFR curve relative to the median dots, the SOFR curve, I think, is getting a little bit more aggressive in terms of pricing out that future rate cut path based on what the Fed is implying. And so there could be a mismatch here.

And again, a risk to the market could be the SOFR curve getting a little bit ahead of itself, a little bit aggressive. Maybe we get some better data over the next couple of meetings. And instead of having consecutive cuts going forward, maybe we end up getting stuck with maybe a pause in there. And I certainly would think the market not going to certainly like that on the back of that.

So in general, I think this is still a pretty good backdrop. Growth was revised higher. The unemployment rate was revised lower. Inflation was revised higher. And so what is this all up against the path of additional rate cuts? It tells us that the real policy rate is moving lower. And that's certainly risk on for risk assets.

And what do I mean by that? Well, what you're looking at here is simply financial conditions in purple. So we're looking at the Chicago Fed's financial conditions. As that purple line moves up, you're talking about financial conditions moving tighter. As it moves down, it's looser.

That 0 line is roughly on average. It tends to hover between 0 and 1 standard deviation, so to speak. And I simply overlaid on top of that the Fed fund rates. And I've got a couple of areas that are highlighted with the blocks. The red blocks are those points where you start to see, really, an elevated starting level for financial conditions, so maybe marginally tighter than historically speaking, or also, at the same time, when you're actually getting financial conditions moving higher.

So the combination of starting level and trajectory-- that's the red boxes. But we've got three green boxes highlighted on here. And those are areas where that starting level of financial conditions is somewhat below normal, or, in some cases, it's actually trending lower.

And so you've got both roughly 1995. And then you can see at the end here, 2018 and '19, and more recently, the end of 2024. And I think we all know what happened during 1995. That was the famous irrational exuberance from Greenspan. Equity markets continued to grind higher.

But if we look at the more recent, I think, examples here, again, we see there going into the end of 2019, Fed was cutting rates. And what do we see with the equity market? Equity market continued to grind higher. And same thing with going into the end of 2024. The Fed was cutting rates. Equity markets continued to grind higher.

So the bottom line for us right here is simply that the Fed is starting to ease into a point where financial conditions are already fairly supportive. And as a result, that's probably going to still remain risk on. So something to keep in the back of your head when you start to think about any drawdowns here as we head into the end of the year.

BRIAN HESS: Thanks for that summary, Jack, and for extending it to market implications or how it could potentially support the idea of buying the dip. We did get one client question or one question from the audience highlighting how the Fed has been a big buyer of treasuries, really, ever since the global financial crisis.

Now, they're not doing that. They're letting treasuries roll off their balance sheet. And yet at the same time, we've seen a lot of issuance. We've seen some weak auctions. So this question has to do with whether a lower policy rate or lower short-term interest rates might create some risk around the Treasury being able to fund its debt issuance at market rates. Do you have concerns around demand for treasuries in light of the rate shift?

JACK JANASIEWICZ: Yeah, we've talked about this on past webinars, where I think short-term, maybe some of those things can play into the demand for treasuries. But longer-term, I think it ultimately still comes back down to the growth backdrop, inflation backdrop. And if both of those remain somewhat benign, I think you're still going to have demand for treasuries going forward there.

So I think maybe short-term, you might potentially have some hiccups along the way with that, but I think longer-term, the trend will still be driven by the fundamental backdrop. And so as a result, I think those longer-term fundamentals probably will end up taking over.

BRIAN HESS: And we've already seen a fair bit of curve steepening this year, which is pricing in that greater term premia on the expectation that the Fed would be lowering rates. So between that and the weakness in the labor market, perhaps there'll be a persistent bid for treasuries, even at slightly lower levels.

JACK JANASIEWICZ: Yeah. And I would also argue anytime you get any whiff of a slowing economy, that bid is going to come right back to the Treasury market.

BRIAN HESS: Right, that makes sense. So staying with the rates theme. I guess, Garrett, let's shift back to you. Earlier in the webcast, you highlighted the weakness in the labor market. One sector of the economy where we haven't seen much job creation at all or contribution to growth has been housing.

And I know you have a few slides highlighting yield curve dynamics. I just mentioned the steepening. So let's talk about those yield curve dynamics, but also, residential real estate-- very sensitive to changes in longer-term yields. And we've seen the 10-year yield move lower in its range on the back of some of the weakening data you highlighted, particularly the labor market.

But so far, we've seen housing prices remain strong, but sales are still very weak, very low compared with history. And in the case of existing housing sales, we're basically at the same type of turnover that we saw right after the global financial crisis. So I guess my ultimate question is is there any reason for us to expect a pick-up in US housing activity anytime soon? Because we know that can have a big contribution to GDP growth. What do you think?

GARRETT MELSON: Yeah, so a couple things. Just to cut to the chase, I think the environment is still fairly challenged for the housing market. Again, it's not something that we're worried about-- a repeat of the GFC, by any means, but I think it's still an environment-- and you're hearing this from some of the largest home builders in the country-- where demand just isn't there.

And they're starting to have to rationalize their pipeline of construction. So if you think about what really drives growth from the housing market, it's that construction spending that actually flows through and gets booked into GDP. And they're telling you basically, they're going to be paring back on breaking ground for new starts.

And construction activity is cooling off. Employment's probably slowing down in that sector as well. And you're already starting to see the signs of that. I think that's probably going to be a trend that's intact for a couple months and quarters going forward in here until we see some more material moves on the rate front. So maybe that's a way to back up to what we were just talking about on the rate backdrop.

For what's going on in the rates market and what's going on in the narrative, I think it's pretty interesting that you've had all these excuses for why rates have backed up, the curve is steepened, whether that's the initial liberation day shock, reduced investor confidence in the US, a political premium, elevated inflation fears.

We had the sell America for a little while. List goes on, but when you take a look at the chart-- this is just a look at some of the major sovereign global curves, just looking at 10s versus 30s-- it's not a US phenomenon. You're seeing this dynamic play out across the world here.

And that generally plays out. Yields are generally fungible across borders here. And so movements and yields in one region might flow through into movements in another area of the world, but I think what's really interesting is when you actually decompose what's driving that curve steepening, not all of these steepenings are the same.

And namely, there's one that stands out. It's the US. The US 10-year yield is actually one of the best-performing, and on this chart, the best-performing global sovereign 10-year bond in the world. It's actually rallied in just as we had this through the end of last week, or earlier this week, I should say. Rallied about 40 basis points in yield.

And you look at the long end of the curve. It's actually been basically flat. So while the steepening on a global basis has basically been this bear steepener, where you've had a sell off at the midpoint of the belly as well as the long end, but it's been more painful and more acute at the long end, it's actually been just the opposite for the US. It's actually been a bull steepener as the tenure has rallied more, as we've repriced this rate cut dynamic coming out of the Fed.

And so I think what's interesting is the consensus is very much on board for this continued steepening, but as Jack mentioned, there's nothing like a whiff of slower growth to really shift the narrative. And if you actually take a look at recent movements, you've actually started to see a flattening in the curve. And this is an area where we leaned against the consensus. We expected that if slower growth, slower labor market activity started to seep through, you'd see the narrative reprice to that.

And you might be setting up for a parallel shift or maybe even a little bit of a flattener. That's exactly what you've gotten here. Maybe a little bit of cherry picking, but if you take the close right before the August payrolls print on September 2 through the yield lows just before the FOMC meeting last Tuesday, you can actually see that that softer data that we've gotten over the course of this month has actually translated to exactly that-- an actual bull flattener in the curve, where the long end's really started to catch a bit in here.

So I think that just pushes back this idea that the Fed starts cutting, that means that rates are going to start backing up, just like we got last year. The starting point is very different. We're not in this growth scare pricing. And that just means that we probably have some two-sided risk from rates.

We backed up a little bit since the Fed meeting, but I think that opens up an interesting question for where do we see rates going from here, and how does that feed back into the housing market. And there's a couple things to just to focus on.

And Brian, as you mentioned, the housing market's been very, very sensitive to movements in the mortgage rate. And this next chart just simply puts that into context. We've inverted the chart in purple, which is the MBA's mortgage purchase application. So we're just zooming in on new purchase applications excluding refinancings.

And you can see it tracks very closely with the 30-year mortgage rate. So as that mortgage rate falls, you see this reflexive pickup in demand. What I will say is that that link has broken down a little bit over the last year, year and 1/2. It's not quite as tight as it's been.

And so what that suggests is that we might actually need to see a lot more, or a much greater move lower in mortgage rates, to actually start unlocking more significant demand. And again, that's a comment echoed by Lennar in its earnings just this past week or so.

So where are we going to potentially get some of that tightening in mortgage rates? Well, for all the focus on the long end of the curve, it's really not the long end of the curve that drives mortgage rates. It's really closer to about the 5 to 10-year window. So call it 7-year tenner.

But there's been this hope that maybe we could see some tightening in mortgage spreads. And that could lead to lower mortgage rates even without the Treasury curve moving lower. And I think that story has really run its course. What you're looking at here is just the current levels of the US 5-year, 10-year blend, so basically, the 7-year Treasury in light blue, relative to the historical average prepandemic, so basically, 2010 to '19.

And then on top of that, we layer those spread components. So you basically have a secondary spread, which is driven by investor demand for MBS. And then you have your originator economics-- basically, your GSC guarantees, originator margins. And that adds on a little incremental spread. And then you're left with what your prevailing mortgage rate is.

Well, if you look at the purple and the gray, those are your spread components. They basically compressed. And you maybe have 30 basis points more to squeeze there. What does that say? It basically boils down to what plays out in the Treasury curve. You're going to need to see a much lower Treasury curve to really drive a significantly lower mortgage rate on the fixed term for 30-year mortgages in here.

Now, the flip side, or I guess, the caveat, is we've started to actually see a little bit of a return for adjustable rate mortgages on the next slide. This is just the share of adjustable rate mortgage applications as a share of total applications. And this is a four-week moving average.

If you just look at the week-to-weeks, you can see we actually marked ticks higher to basically the highest level we've seen since 2008. So it's a notable uptick, but that said, it's still only about 12%, 13% of the total or mortgage application activity here. So it's fairly muted, but maybe starting to see some ways that potential buyers are finding ways to get creative and maybe bank on a shorter-term outlook and hope to refi at lower rates five or seven years out.

But that said, I think the bigger story is going to continue to be what's playing out in the housing market. On this final slide, again, it goes back to what is under construction here. And it's just simply not a great backdrop for home builders. If you take a look at new single family homes for sale-- this is completed inventory in the light blue-- that just continues to grind higher.

And no surprise. If you don't have a lot of demand and you continue to have increase in supply, completed inventory, what do you think homebuilders are going to do? They're going to start paring back on starts. And that's exactly what you're seeing in here.

So you're in an environment where basically, the units under construction are falling. Homebuilder sentiment is pretty weak. And to the extent that construction continues to fall, you're probably going to see some downside for employment in here.

So I think the near-term outlook is just not one of the bottom falling out, but one where you probably continue to see some downside in housing. And it's going to take much more material to move lower in the Treasury curve to unlock a lot of that activity.

BRIAN HESS: Garrett, I'm starting to see a pattern here where you bring the bad news and Jack brings the more optimistic perspective. I think it's time we go back to Jack.

GARRETT MELSON: I pulled the bad cop card today.

BRIAN HESS: Yeah, you sure are. So Jack, we've spent a lot of time talking about economics so far. Let's shift to markets for a bit. There's been a staggering rally in global equities since the 90-day tariff pause was announced on April 9. And I think the rally in US large caps probably exceeded most people's expectations.

So during this time frame, as we think about going back to April, what have you seen from a flow standpoint? And what's your current read on sentiment and positioning? To me, anyway, we feel stretched, but how stretched are we? What does the data say?

JACK JANASIEWICZ: Yeah. And like you just said, I think I'll bring a little bit more good news here, but maybe a quick comment. I've been on the road quite a bit in conversations with clients. That wall of worry, I think, still persists. Get a lot of questions about valuations. Can we get the CapEx AI story-- continue to persist. The list goes on and on.

And yet here we are, continuing to grind up to all-time highs. And so I think that's a little bit of an interesting data point, but when I start to look at the actual numbers that we're about to run through here, it's probably a little bit more mixed. I think you get a little bit more positive backdrops from some of the flow and positioning standpoints in particular markets.

But I certainly want to highlight a risk in here going forward that we potentially could see a little bit of a shakeout if volatility were to spike. But first things first, in this first chart here, we're just looking at flows coming into ETFs and long-only products for the US markets.

And basically, you can see a big spike in that most recent reading. That was something close to the tune of about $58 billion worth of inflows coming into US equities, whether it be ETFs or long-only products, but what was pretty interesting, if you go all the way back and look at flows coming in, basically since liberation day, the US markets have been in outflows.

So maybe we're finally starting to see a little bit of a turn in the tide here, where some of that sentiment is shifting more in favor of the US because what's interesting-- in this chart here, we're simply looking at the rolling six-week cumulative flows as a percentage of assets under management for some of these regions. It tells us a pretty interesting story.

So you can see here in the light blue line, we've had a pretty big tick-up in terms of flows coming into the US. And I think people really front-running the potential upside with the Trump presidency, looking at some pro-growth policies being enacted. So you get a massive influx of people pouring money into the US markets, all at the expense of what was going on in Europe. But all of a sudden, you see a sharp reversal in that flow. And then you can almost call that light gray line there panic buying, as money pours back into Europe, all on the back of what we were seeing with regard to that America-first policy, if you will.

And so a sharp reversal in flows, but more interestingly, if you look more recently, what are we seeing with those European flows? They're just petering out. And then of course, you can see that big uptick more recently, reflecting that last week of inflows into the US market.

So we're certainly seeing a little bit of cooling for some of the enthusiasm for those international markets, specifically with Europe. And it's really not surprising because when we look here at performance and we're simply looking at performance of Europe relative to the US, and I've got both local currency returns and US dollar denominated returns for Europe, you can see in the gray line here-- that's local market returns for the MSCI Europe-- it really hasn't gone anywhere. It's been trading sideways.

And if you actually go back and look at performance since May 20, through the close of yesterday, MSCI Europe and local currency terms was up only 62 basis points. So again, looking at what the purple line is doing relative to that gray line, that's all basically related to the euro appreciation.

So from an investor standpoint, you're really only getting positive returns from early part of May in Europe. And it's all been currency-related, but still, from a total return perspective since liberation day, we've since seen the S&P start to actually take over in terms of that relative performance.

So again, not surprising when you go back and look at those fund flows, how all of a sudden, that euphoria is petering out. And you're seeing money coming back to the US simply because Europe's been basically trading sideways for some time. So the question there is do we get a lot of things priced in right off the bat, especially when you start to talk about the defense spending and some of the infrastructure spending that we've talked about?

But if you broaden out the lens, I think there's a couple of different things worth highlighting here. Again, when we think about retail sentiment-- and this is just looking at the American Association of Individual Investors survey-- you're still looking at readings for the respondents that are coming in as bearish still being elevated.

So again, individual investors on the retail side still leaning a little bit bearish. Again, I think this corroborates what we saw in the flow data that I'd just shown. And then if we look something closer to maybe what the advisors are doing-- and that's what this is called with the National Association of Active investment Managers here-- maybe a little bit more optimistic, but certainly far from being over their skis, so to speak, in terms of their bullish outlook.

So probably a little bit more optimistic, but again, room to see that expand even more so. So again, somewhat of a wide divergence in terms of that backdrop in sentiment, but to me, the bigger issue here-- and this is maybe potentially what could set us up for maybe a short-term correction in the markets-- it's really those leveraged players.

And what you're looking at here, that gray line at the bottom-- you're just looking at one month realized volatility for the S&P 500. And then that purple line-- you're just looking at the equity exposure for risk control funds that are targeting that 10% volatility.

So think about this. As volatility in the market continues to fall, these guys actually ramp up and take more and more exposure to the equity market, but then when volatility spikes, they have to end up derisking. And again, with volatility compressing both in the bond market and in the equity market, the equity market almost to all-time lows again, you can certainly make the case that a lot of these leveraged players are ramping up that equity exposure.

And you get that sense looking at the purple line. And although we don't have the chart here showing some of those numbers going forward, I think when you start to look at things like the vol control funds, CTAs, we're all getting the same readings, where these guys are actually pretty long in the equity risk.

So any volatility bump that we might see here in the short term could lead to some derisking from these leveraged players. And that might eventually lead to a pullback in the market. And certainly, I know we've been talking about potential softening in the labor market data.

Maybe that's what we actually end up getting as the catalyst in here, where we get a little bit of a correction, but from our perspective, if we do get that vol spike, you get that deleveraging from some of these players, we'd be actually probably better buyers on that dip going forward.

BRIAN HESS: Jack, you mentioned we'd be buyers of what sounds like US stocks on a dip. And you also showed a couple of charts about Europe. I'm surprised we haven't gotten a question today about international equities. I know it's come up in a lot of meetings that our sales force has been having, that you've been having on the road. In the models we manage, our biggest underweight right now is developed international equities, a lot of which is Europe. So do you have a preference for US stocks over international stocks?

JACK JANASIEWICZ: Yeah. Again, we're still leaning a little bit into US equities. And I think it's really a function of those tailwinds. It continues to be the AI-driven story, that CapEx story. And where do you see the largest growth estimates being revised higher? It's still coming in that tech space.

And so when you talk about the AI trade-- so it's going to be a combination of comm services and also some of the tech space-- then you're probably talking somewhere north of 40% of the S&P 500 somehow attached to that AI trade. And I think there's still evidence that that's still playing itself out. And so that's where we'd prefer to have those exposures going forward.

BRIAN HESS: OK, yeah. That makes sense. Another thing we've been looking at on the international front is emerging markets, where in one of our more recent trades, we actually added to our overweight within EM equities. So really, what we have on is an overweight-to-emerging and underweight-to-developed. You were a big proponent of adding to emerging market equities. Do you just want to a minute to highlight what you're thinking there, and the thesis behind that position?

JACK JANASIEWICZ: Yeah. And I think that the easiest way to summarize this is simply that it's the chart that we ran through earlier when we were talking about financial conditions. When financial conditions are loose and easing even more, and you have a Fed that's going into an easing cycle, that's probably just going to add to the looser financial conditions. That tends to be generally risk on.

And I think when we start to look at where a lot of that excess risk could end up finding its way into, it's emerging markets. And certainly, we've seen some good performance out of emerging markets, but again, when we start to look at our positioning and flow data, it certainly looks, at least from the retail perspective, that you have not seen a huge move into EM yet. So trying to get ahead of that game. We think they're going to be one of the biggest beneficiaries-- EM is-- of the easing financial conditions going forward here.

BRIAN HESS: Great. Thank you, Jack. And so, yeah, in summary, we are overweight EM, underweight DM, and looking to be buyers of weakness into US stocks. Now, we're getting into the last part of the webcast here. It's 10 of the hour. So I'm going to stay with you, Jack.

And I think maybe if we could just take a little bit of a look at the internals of the US market, the message we're getting from that angle, and then maybe if you have a few charts that you could use as an opportunity to tie everything together, where we hit on with the labor market, with inflation, with the Fed, and with our view on the forward returns for the stock market.

JACK JANASIEWICZ: Yeah, and I'll try to go through these last couple of charts quick because I think a lot of these are going to be self-explanatory here, but I'll provide a little bit of context. But again, one of the things that we like to fall back on is what is the market telling us?

And so if we just look at different sectors and segments within the market and their relative performance, you get a little bit of a story that can flesh itself out. And so what you're going to look at over these next couple of charts here-- the top pane is going to be the absolute price levels. And then the bottom pane is going to be that relative performance.

So in this case, we're simply looking at the equally weighted cyclicals relative to equally weighted defensives. We can constructed this ourselves. So you're just looking at an equally weighted basket of those individual sectors within the economy.

And what's notable here-- that purple line-- you're looking at defensives. They've been basically trading sideways for almost all of this year, but if we look at the cyclicals, they're continuing to grind higher. And so when we look at that bottom pane, that relative performance, cyclicals continue to grind higher relative to defensives and are making, basically, new highs if we look at discretionaries versus staples.

So again if people are starting to batten down the hatch, you'd expect discretionaries maybe to start underperforming, getting a little bit more defensives, those staples, part of the market going to outperform. Again, if I look at where staples are trading, that light blue line there, in the absolute sense, they're actually heading south. And if I look at discretionaries, that continues to grind higher. And that relative performance-- again, same thing, breaking out, making new all-time highs.

And the last one worth highlighting here-- low volatility versus high beta. And again, high beta continuing to grind higher. Low vol continuing to trade sideways. And that relationship's relative to each other grinding higher. So again, these are indications that are what the market's telling us.

And in all these cases, these are certainly risk-on metrics that we're pointing to. And so I think what the market's reacting to is telling us that things are moving up. And I think we certainly walk through the case where potentially, we're seeing a little bit of a slowing in the labor market side.

And so how can we continue to see discretionaries, for example, pushing higher? How can we see these cyclical components pushing higher? And I think some of that has to do with maybe this bifurcated consumer, if you will. And a couple of things worth noting here. This comes from the Fed's distributional financial accounts.

We're just simply looking at what I would consider to be cash and cash equivalents in blue. And then we're looking at basically the liabilities, but outside of mortgage debt. And I think what's worth noting here on the far right side-- the lower 50% of all Americans basically have more nonmortgage debt than liquid assets.

Compare that to the far left there, which is the top 10%, and you can see it's just the opposite. Almost no debt and sitting in highly liquid cash alternatives. And so if you think about this, as rates are moving higher, that lower 50% bore, really, the stress from higher interest rate costs and had no benefit from, basically, the markets going higher or earning that excess return on cash, where money markets were clipping something north of 4%.

And at the same time, that cohort's also actually still seeing weaker wage growth going forward here. And this is all at a time when the labor market is coming under pressure. So you can see here again that the fourth quartile income distribution is that purple line, that light purple line-- yeah, they didn't certainly see the significant growth coming out of COVID, but they're also not seeing it unwind on the other side as well.

And I basically looked at the changes since the end of 2022. And the higher income quartile really has not seen any wage growth or wage loss, whereas if you look at that lowest income quartile, that first quartile, so to speak, they've seen a marked deceleration in that wage growth.

So when we start to think about what's driving everything, it really comes back to that upper income quartile. And again, we've shown this before, but the point being here-- the ones that are seemingly getting pinched, the ones that are potentially seeing the weakness in the labor markets-- that really focuses on that left hand, the lowest 20% or 40% deciles here, or quartiles, in terms of those income cohorts.

But when we actually look at their contribution to overall consumption, it still remains pretty low. So the bulk of consumption still gets driven by the upper income bands. And those are the ones that are still benefiting the equity markets pushing higher, that better balance sheet perspective, so to speak. And I think that's one of the reasons why we can continue to point to why things are still holding up from a stock market perspective, even though we might be seeing some labor market weakness.

A couple other ones to really point to-- again, spreads. The corporate bond market continues to basically say things are in good shape. And I would point to the investment grade spreads at 72 basis points over for the benchmark index there. That's an all-time tight. So keep that in mind. You're not seeing any concerns coming out of the fixed income markets.

When we start to look at earnings estimates, they continue to grind higher. So what we're looking at here is simply the next 12 months earnings estimates for both the S&P, the Dow, and the NASDAQ. They're all pushing higher. And quite frankly, they're all making all-time highs. I don't think that's something that we would consider to be bearish going forward.

And then the last one-- we get a lot of questions about valuations. Keep in mind, though, that as volatility continues to compress, that tends to actually lead to multiple expansion here. So you're simply looking at the move index, which is going to be your 30-day implied volatility for the Treasury market curve overlaid on top of the forward PE for the S&P. And again, that move index is inverted. So as we continue to see Treasury market vol drop, that implies well, we probably should see multiple expansion. And that's what we're actually seeing.

So the bottom line here-- I think there's a lot of reasons to be optimistic going forward here. Certainly not going to gloss over the idea that we potentially could see further weakness in the labor market, but I think if we continue to see further weakness, you're probably going to have a Fed response to that. So you somewhat of a circular reference there.

But regardless, the backdrop still seems to be very supportive. And again, we might get a hiccup. Any sort of vol spike-- as I mentioned, some deleveraging from those the leverage players-- we would actually be looking to buy on that dip and getting a little bit longer as we go into the end of the year. So we remain somewhat optimistic that you should be actually overweighting equities for the last quarter of the year.

BRIAN HESS: Thanks, Jack. That last series of charts, I think, does a good job of explaining why we're not hitting the panic button, despite some of the weakening labor market trends that Garrett highlighted at the beginning of the call. So thank you for that.

We got one more question. I think we have time for it. It relates to the EM equity comments we made just a few minutes ago. So another Jack in the audience-- he asked about our feelings with respect to China making up such a large component of the most EM equity indices, and if we're comfortable taking on that China equity risk as we go overweight, emerging market equities. What are your thoughts on China? We have a position, I should say, by the way, in FXI, which is a China-focused ETF. So that spoils it, but what do you think about China, Jack?

JACK JANASIEWICZ: Yeah. It's one of our bigger overweights when you start to think about specific country allocations within the emerging market basket. And I think maybe you could think about it as a hedge relative to what we're seeing coming from a lot of those tech-related Mag Seven names, the AI trade in the US-- because the biggest competition is coming out of China.

And so if we start to get a little bit of concern for the US backdrop, I think you're starting to see China, Chinese equities, and specifically, that AI trade, playing catch up in here. So I think that's one of the few markets where you can actually have that tech-related trade still in play.

Certainly, I think we're seeing the arms race between China and the US playing itself out. I think that probably still bodes well for some of those China tech names. And as a result, we think that's probably the right way to play this. You still want to have that overweight-- the Chinese equities because of that theme.

BRIAN HESS: Valuations are a lot less demanding. And we also seem to have a fair bit of state support for the equity markets. So that can't hurt, either.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: OK. Well, thank you very much, Jack and Garrett. This was great. We covered a lot of ground, but we're going to have to leave it there for today. Again, thank you to everyone in the audience. We love doing these webinars with you all. So thanks for joining and making it possible. We appreciate the partnership. If anyone has questions related to what we covered today, just please reach out to your Natixis sales rep. And we'll see you again next quarter. Thanks very much.