Yanni Angelakos, Head of Investment Insights, Nasdaq Capital Access Platforms
A Moderating U.S. Economy Balanced by Supportive Market Indicators
- U.S. economic activity is stable but slowing, accentuated by labor market weakness
- However, equities continue to price in a broadly stable outlook
- Near-term risks are market and investor complacency amidst the weakening employment backdrop
Summary
There is the market economy with equities continuing to hover near all-time highs, and then there is the real economy. The U.S. real economy has slowed, particularly on the employment front, as Corporate America is in stasis given the ongoing need for clarity and resolution to trade tariff uncertainties. This will likely be an ongoing theme as the reality is it takes time for policymakers to agree on definitive tariff rates across major global economies. Regardless, the U.S. economy has, again, proved itself to be relatively resilient in the face of the oft discussed (including in these pages) macro headwinds, driven by corporate strength and incredible technology-oriented capex. This investment is namely via the AI “hyperscalers” of Amazon, Apple, Google, and Microsoft which are expected to deploy nearly $400 billion of capex in 2026 alone—2.5 times as much as in 2023.
Taking a step back, the strong corporate earnings backdrop and relatively steady consumer demand have been key tailwinds for equities. However, now that we’re past Q2 earnings season, the focus is squarely on the increasing cracks in the labor market as a material worsening of the employment landscape from here will increase concerns of weaker confidence and lower spending trends. Hence, post the softer August NFPs and the annual NFP revisions, the markets are pricing in at least one Federal Reserve cut at the September 17th meeting, up to three by the end of 2025, and ultimately up to six rate cuts through the end of 2026—currently a total of nearly 150 basis points in cuts. Consequently, equities are balancing the expected Fed rate cuts on top of what have been easing financial conditions with a deceleration in employment growth. The risk for investors through year’s end is a level of market complacency, particularly as the employment picture has weakened further. This is amidst an upward recalibration of economic sentiment gauges and investor sentiment from the lows in the first half of this year, which have improved as the trade tariff rhetoric has stabilized.
Biweekly Chart in Focus: Fed Funds Futures Reflecting a Moderating U.S. Economy with up to 6 Rate Cuts Priced in by December 2026
Source: Bloomberg. Notes: Chicago Fed National Activity Index (CFNAI) is a weighted average of 85 monthly indicators across four data categories: 1) production & income (23 series); 2) employment, unemployment, hours (24 series); 3) personal consumption & housing (15 series); 4) sales, orders & inventories (23 series). 0 corresponds with the national activity expanding at its historical trend (average) rate of growth; negative values with below-average growth & positive values with above-average growth (measured in SDs). Periods of economic expansion have historically been associated with values above -0.70 & periods of economic contraction (i.e., recessions) have been historically associated with values below -0.70.
Details
A Weakening Employment Backdrop
For a holistic view of the U.S. economy, the chart above shows the smoothed out three-month moving average of the Chicago Fed National Activity Index (CFNAI). Though not as widely publicized as other monthly economic data series, this is one of the more comprehensive, timely aggregates of U.S. economic activity as it is comprised of 85 monthly indicators across four categories (see the footnote for more details). When plotted against the real-time Fed Funds December 2026 contract (which investors use to derive the probability of the Fed Funds rate as of December 2026), this tenure tends to lead the CFNAI’s three-month moving average by one to two months—further portending this trajectory of weakening economic activity. This trend is also reflected in Treasury 10-year yields at around 4.05% (lowest since peak trade tariff concerns in early April 2025) and in the more Fed rate sensitive Treasury 2-year yields at approximately 3.50% (lowest since September 2022). With at least a 25 basis point cut widely expected to be a certainty at the September 17th FOMC meeting (when the Fed’s latest economic projections will also be released), investors will be watching closely for any indications that the Fed is concerned about stagflation given a still sticky inflation environment, particularly on the goods side.
A key component of this economic moderation is the weakness in U.S. labor market indicators. Following the August NFPs, the six-month moving average is now 64,200 and the three-month moving average is 29,300. This leaves both series at their lowest since January 2011 and September 2010, respectively, excluding the volatile Covid-19 period from March to December 2020. The unemployment rate has inched up the past two months to a still-low 4.3%—but at its highest since October 2021 as hiring momentum has waned.
In addition to the monthly payrolls report, the extremely high level of job openings, which peaked at 12.134 million in March 2022, was a key focal point when discussing the tightness in the labor market in the aftermath of the Covid-19 period. Contrarily, the recent decline in job openings is part of the discussion amidst the softening jobs picture. At 7.181 million total openings as of July, this is hovering near the lowest level since December 2021 and is now -41% from the Q1 2022 highs during peak labor market tightness (Figure 2). As Michael Normyle, Nasdaq’s Senior U.S. Economist, noted: “there are now 0.99 job openings per unemployed person – the first time this ratio has fallen below 1 since April 2021, indicating that demand for workers is softening somewhat faster than supply is slowing (mostly due to less immigration).” Again, the strength of the U.S. private sector and corporate earnings is countered by a flat-lining of job creation given the macro uncertainties facing companies.
Figure 2: Job Openings at Their Lowest Since December 2021 as the Labor Market Thaws Further
Source: Bloomberg
Market Pricing & Economic Sentiment Gauges
The above spoke to the real economy. The market economy has broadly traded sideways over the past month, but U.S. equities continue to hover near their highs given the earnings construct which has helped investors justify still-elevated valuations (e.g., Nasdaq-100 Index® (NDX®) has a next twelve month P/E ratio of 26.7x and the S&P 500 Index trades at 22.3x—both a 19% premium relative to their respective 10-year averages). It can be a narrow path for the market narrative that the U.S. economy is weakening at just the right pace for the Fed to begin a rate cutting cycle, which is supportive of equity returns (Figure 3)…but that economic activity is not slowing substantially enough to warrant recession concerns.
Figure 3: Equities are Counting on Fed Rate Cuts to Counterbalance the Slowing U.S. Economy
Source: Morgan Stanley. Notes: excludes recessions
That is why it is also informative to look at what the market is pricing in for the real economy if looking at equity proxies and more forward-looking sentiment indicators. Figure 4 illustrates how NFIB’s Small Business Optimism Index stabilized and has more recently rebounded off of its lows on a year-over-year basis as the worst-case trade tariff scenarios have not played out and as the tax cut legislation was enacted into law. Despite the moderating economy, to which small cap equities are more geared, they have rebounded in absolute and relative terms given their sensitivity to lower interest rates (as we discussed in our last report). Figure 5 shows that, perhaps surprisingly given the ongoing angst around the global construct, 18 out of 34 August manufacturing PMIs across DM and EM economies (nearly 53%) are in expansion territory (>50)—the highest since April 2024. This rebound in global manufacturing sentiment is reflected in the Goldman Sachs U.S. Cyclicals vs. Defensives Index which, as of the end of August, was higher by 8% on a year-over-year basis—the highest since February 2025 when the U.S. trade tariff rhetoric began to spark global concerns.
Figure 4: U.S. Small Caps Have Stabilized YoY as Small Business Optimism has Rebounded
Source: Bloomberg
Figure 5: Rebound in % of Global Manufacturing PMIs in Expansion Reflected in U.S. Cyclicals’ Relative Performance
Source: Bloomberg. Notes: the GS basket pair trade represents an equal notional pair trade of going long cyclicals & short defensives, ex-commodities.
Signs of Market Complacency & Elevated Retail Investor Sentiment
Pari passu with the rebound in risk assets, investors also have to constantly monitor for market complacency from a risk management perspective. Figure 6 shows how equity volatility and U.S. corporate high yield spreads relative to Treasurys remain at very low levels. Concurrently, the spread between the American Association of Individual Investors (AAII) bullish and bearish readings has rebounded drastically and, unsurprisingly, matches with the strong rebound in equities (Figure 7). However, this is interestingly juxtaposed by the latest report from Nasdaq’s Chief Economist, Phil Mackintosh, which examines retail flow data that points to the retail investor actually fading the equity rally. As such, while the sentiment data shows a bullish reversal amongst retail investors, the hard data presents a picture of a more cautious retail outlook. Given U.S. households represent the largest share of U.S. equity ownership at 38% (per Goldman Sachs), the sentiment and trends of the U.S. retail investor remain a powerful force to monitor. This is particularly the case as this segment has been a source of market support during mini sell-offs since the equity market April lows with nearly $7.3 trillion still on the sidelines in U.S. money market funds (per the Investment Company Institute).
Figure 6: U.S. Corporate High Yield Spreads & Equity Volatility Remain at Very Low Levels
Source: Bloomberg
Figure 7: AAII Bull-Bear Investor Sentiment vs. Nasdaq-100
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