Split economy — business CapEx (AI/data centers) + fiscal spending drive growth, consumers squeezed by inflation + labor softening, Fed cuts under political pressure despite above-target inflation
The Fed is cutting into a growing economy with fiscal tailwinds — historically the best setup for risk assets
The bet is that the Fed keeps cutting through 2026 even with above-target inflation, under political pressure and concern about labor softening. Lower rates reduce borrowing costs for businesses and consumers, support asset prices, and make risk-taking cheaper. The 10-year yield and real rates show whether markets believe the cuts will stick or whether long-end rates are fighting the Fed.
Inflation re-accelerates and forces the Fed to pause or reverse — real rates stay high, long-end yields spike, and the rate-cut tailwind evaporates.
Fed Funds Rate, Real Fed Funds Rate, 10-Year Treasury, 10-Year TIPS Yield
Fed Funds accommodative at 3.64%, down 170bp over two years. Real rate at 1.05% has actually firmed from the near-zero levels of early January, sitting in neutral policy territory rather than financial repression. The 10Y at 4.09% is fair value — it's cooperating with the cuts, down from 4.47% a year ago.
The bet is that inflation stays above the Fed's 2% target but doesn't re-accelerate — a 'hot but stable' regime that gives the Fed political cover to keep cutting. Core PCE and CPI track actual price pressures, while UMich expectations and breakevens show whether consumers and markets believe inflation will stay contained. If expectations become unanchored, the Fed loses its ability to cut without triggering a confidence crisis.
Core inflation re-accelerates above 3.5% or expectations spike — the Fed is forced to pause cuts and may need to tighten, removing the key pillar of the thesis.
Core PCE YoY, Core CPI YoY, MICH, 10-Year Breakeven Inflation
Core CPI at 2.51% is near target and the January headline CPI surprise at 2.4% was the freshest confirmation. Core PCE at 2.79% runs hotter but is trending in the right direction. Breakevens anchored at 2.27%, and 1-year inflation expectations have dropped sharply to 2.59% from the 3.2% that worried us last month — a meaningful de-escalation.
The bet is that the labor market softens gradually but doesn't crack. AI and productivity gains offset some job losses, keeping unemployment from spiking. The Fed watches labor closely — a rapid deterioration would shift cuts from 'gradual easing' to 'emergency rescue,' which is a different (and worse) scenario for risk assets. JOLTS openings show whether businesses are still hiring, while initial claims are the earliest warning of layoff acceleration.
Unemployment jumps above 5% or initial claims surge past 350K sustained — the soft landing narrative collapses and the Fed is cutting into a recession, not a growing economy.
Unemployment Rate, Initial Jobless Claims, JOLTS Job Openings
Full employment holds with unemployment at 4.3% and claims at 227K in healthy churn territory. Job openings at 6,542K are still healthy demand, though the trend from 8,445K two years ago is unmistakably downward. No cracks yet, but the trajectory bears watching.
The bet is that consumers are squeezed from both sides — persistent inflation erodes purchasing power while the labor market softens — but they keep spending by drawing down savings and taking on debt. This is the weakest link in the thesis: consumer spending drives 70% of GDP, and a consumer pullback would undermine the growth story. Savings rate, sentiment, delinquencies, and debt service ratio together paint the picture of how much runway consumers have left.
Savings rate drops below 3%, delinquencies spike above 4.5%, and sentiment craters below 70 simultaneously — consumers are tapped out and spending contracts.
Personal Savings Rate, Consumer Sentiment, Credit Card Delinquency Rate, Debt Service Ratio
The weakest link remains weak. Sentiment at 52.9 is pessimistic — barely above the 50 line we flagged as critical. Savings rate at 3.5% is stretched, down from 6.1% two years ago. The saving grace: delinquencies at 2.98% have actually improved from 3.17% two years ago, and debt service at 11.26% is manageable. Consumers are unhappy but still functioning.
No strong directional bet on credit — it's a monitoring component. Credit spreads are the bond market's real-time vote on corporate health. BBB spreads show investment-grade stress (the line between safe and risky), while high-yield spreads show junk bond risk (the most vulnerable companies). When spreads are tight, money is cheap and flowing. When they blow out, refinancing becomes expensive and weaker companies start defaulting.
BBB spreads above 2.5% and HY spreads above 6% sustained — credit conditions are tightening enough to choke corporate borrowing and trigger a wave of downgrades.
BBB Corporate Bond Spread, High Yield Spread
BBB spreads at 0.99% are tight but edging up from 0.96% a month ago. High yield at 2.92% has widened more meaningfully from 2.62% a year ago — not stress, but the direction is wrong. Credit markets are reaching for yield while quietly repricing risk at the margins.
The bet is that government spending continues to flow — infrastructure, defense, AI investment incentives — supporting headline GDP growth even as the private consumer weakens. Debt-to-GDP is the key constraint: markets tolerate elevated debt as long as the economy grows and interest costs stay manageable. A fiscal pullback (austerity, spending cuts, debt ceiling crisis) would remove a key growth pillar.
Debt-to-GDP above 130% triggers bond market anxiety, or a political crisis forces spending cuts — the fiscal tailwind disappears.
Debt/GDP Ratio
Debt/GDP at 124.3% is in deteriorating territory, up from 119.4% just two years ago. Monthly deficits of $257B during a non-recessionary economy are historically unprecedented. Tariff revenue surged 300% but that's a consumption tax, not a fix.
The bet is that GDP stays positive, driven by business CapEx (the AI investment boom) and fiscal spending, even as the consumer weakens. GDPNow provides the real-time GDP nowcast while WEI gives a weekly pulse on economic activity. Together they show whether the growth story is intact or whether the economy is rolling over.
GDPNow drops below 1% or WEI turns negative — growth is stalling and the thesis shifts from 'rate cuts into growth' to 'rate cuts into recession.'
GDPNow Real-Time GDP Estimate, Weekly Economic Index
GDPNow at 4.24% is running hot — almost too hot, which is why it flags yellow on thresholds. But WEI at 2.70% confirms healthy underlying momentum. The economy is growing, driven by business CapEx and fiscal spending exactly as the thesis predicts.
No directional bet — this is a monitoring component for risk appetite and market structure. VIX shows implied volatility (fear vs. complacency), while S&P 500 vs RSP shows whether gains are broad-based or concentrated in a few mega-caps. A narrow rally with rising VIX is a fragile market. Broad participation with low VIX is a healthy one.
VIX above 25 sustained with extreme market concentration — the rally is fragile and vulnerable to a sharp correction.
VIXCLS, Market Breadth
VIX at 20.82 reflects elevated but not panicked uncertainty. Market breadth at -5.92 tells a nuanced story — the equal-weight S&P is outperforming the cap-weighted index, meaning the average stock is doing fine while mega-caps drag. This is broad participation with a rotation twist.