Testing the Fed
Weekly Market Update
Top Three Takeaways
Another round of headlines targeting the Fed's independence supports our conviction in gold over duration in the near-term. Two-way volatility can persist around these events, though effects typically fade quickly.
Productivity growth, which is an important driver of corporate profits and household income over the longer term, continues to accelerate in the U.S. and outpace other major economies.
Early earnings point to resilient fundamentals. As the season progresses, guidance should help re-anchor markets in earnings growth rather than multiple expansion.
This Week in Charts
Looking Closer
Productivity drives corporate profits, which supports business hiring and investment. Trend output growth in the U.S. has nearly doubled from a decade ago. This productivity growth far outpaces other major economies and is a primary driver of fundamentals.
Market and Data Recap
Despite more headlines, there are important lines of defense for Fed's independence.
The independence of the Federal Reserve is under intense scrutiny once again following a statement from Fed Chair Powell disclosing the Department of Justice issued subpoenas regarding his testimony on Federal Reserve building renovations. Powell directly connected these legal actions to an effort to influence monetary policy, though President Trump denied prior knowledge of the subpoenas and any intent to enact that influence.
Initial market reactions were modest, though predictable: equity prices fell, the dollar depreciated, and longer-term Treasury yields and gold prices rose from another bout of U.S. policy uncertainty. This aligns with our portfolio's strategic underweight on duration and favored gold exposure as a hedge to geopolitical events.
It is widely understood that shielding central banks from political pressure enhances monetary policy credibility and fosters more optimal economic and inflation outcomes. While political pressure on monetary policy is not new, the public nature of these events and the Fed Chair’s forceful response is unprecedented.
We agree with the market’s subdued reaction as the Fed has recently and unequivocally asserted its autonomy. First, while Chair Powell affirmed his commitment to his role with integrity, the unanimous vote of the Fed’s Board of Governors to reappoint regional Fed presidents, some of whom favored less accommodative monetary policy, also demonstrated a unified front. Second, the Supreme Court has previously avowed the Fed's distinct independent agency status and offered protection via precedent, particularly concerning presidential removal powers, as seen in its stance on Governor Lisa Cook. Third, legislative checks are actively engaged. Senator Thom Tillis, a Republican on the Senate Banking Committee, vowed to block any Fed nominees until these legal issues are resolved, highlighting concerns about the Department of Justice's impartiality. These combined defenses illustrate a resilient framework designed to preserve central bank autonomy.
Regardless, and as we discussed in our Q1 “The Short and Long,” geopolitical events like this present temporary opportunities via market volatility that quickly fade in effect. We will likely see more policy, geopolitical, and fundamental events this quarter driving similar investor angst. However, we recommend staying anchored in fundamentals as these do not undermine conviction in our core positions. The interest rate market seems to agree as it prices in fewer rate cuts this year, focused more on the resilient economy than the ongoing political pressure — in line with our view entering 2026.
Bottom Line: The market’s subdued but predictable reaction to new headlines around the Fed’s independence will quickly fade as most geopolitical events do — though this will not be the last event this quarter. Around these volatility bouts, we want to stay anchored in our core convictions, which currently include preferring gold over duration as a hedge to uncertainty.
Productivity, a primary driver of fundamentals, continues its impressive growth in the U.S.
Productivity growth underpins corporate profits, which in turn drives business hiring and capital investment decisions. Productivity is also a key determinant of household real income growth trends and living standards. Data published last week showed a sharp rise in U.S. nonfarm business sector productivity of almost 5% in the third quarter of 2025. The Atlanta Fed’s GDPNow tracking puts fourth-quarter real GDP growth at around 5%. Combined with Friday’s December employment report that showed private-sector hours worked up only 0.5%, productivity appears to have risen strongly in the final quarter of 2025.
Trend productivity growth — best measured over longer horizons because of the volatility of shorter-run productivity changes — has picked up to around 2% per year in the U.S. from less than 1% a decade ago (see Figure 1). On the same basis (measured over six years to capture, but not be distorted by, the massive swings in output and employment due to Covid), productivity has barely risen in the U.K. (0.2%) and Eurozone (0.1%) and is flat in Japan.
Bottom Line: Productivity growth is accelerating in the U.S. and continues to vastly outperform the growth in output per hour in other major economies.
4Q25 earnings are underway and look poised to provide fundamental market support.
Earnings season formally kicked off on Tuesday in the US. This week’s calendar is dominated by Financials, with several large banks reporting over the next several days. We expect banks to deliver another solid quarter of YoY earnings growth, supported by further improvement in net interest margins, higher investment banking and trading revenues, and a still relatively benign credit environment. The outlook for 2026 should be similarly constructive and benefit from a continuation of several of these trends, with potential upside from ongoing de-regulatory momentum for the sector.
Other key areas that we’ll be focused on include commentary from bank management teams around the health of the consumer, potential for further acceleration in loan growth in 2026, and the outlook for capital markets businesses given optimism for more robust M&A activity. In summary, we expect the fundamental backdrop for banks to remain supportive this year.
In terms of the broader earnings season outlook, consensus expects 8% YoY EPS growth for the S&P500 in 4Q25, decelerating from +15% last quarter before reaccelerating this year. Tech is expected to remain the strongest driver of earnings growth, with Financials and Communications among other key sectors contributing positively, although growth for the index excluding Tech is forecast to be relatively muted in aggregate this quarter. That said, guidance for 2026 will be the most relevant watchpoint for investors. EPS for the S&P500 is forecast to increase 14% in 2026 — still led by Tech, but with healthy growth expected across most sectors.
Given the dominance of the Tech sector both in terms of index weight and as a driver of expected future earnings growth, the evolution of AI-related capex and spending will remain a central area of focus for markets. We expect upside surprises to AI-spending and adoption this year to drive refreshed interest in Tech equities.
Bottom Line: We expect that earnings growth rather than multiple expansion will be the primary driver of U.S. equity performance in 2026, in line with what we observed last year and underscoring the importance of staying grounded in fundamentals. We remain constructive on U.S. equities and continue to favor sectors where we see strong fundamentals, including Tech and Financials.
See our weekly CIO Strategy Bulletin for more details