Hope for Rate Cuts, AI Optimism Fuel Market Rebound

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Trade tensions and delays in data resulting from the government shutdown fueled significant market volatility last week, further complicating the long-term outlook for tariffs, inflation and monetary policy. A loan default at one U.S. regional bank and alleged fraud at another also fueled worries about broader credit quality. But enduring investor optimism surrounding artificial intelligence and signals from the U.S. Federal Reserve that it could once again cut interest rates this month trumped economic and political uncertainty to fuel a rebound by the end of the week.

The ongoing trade war between Washington and Beijing heated up after U.S. President Donald Trump announced intentions to impose sweeping 100 percent tariffs on a wide range of Chinese imports in response to China’s export curbs on rare earth metals, sending shockwaves through global markets and erasing over $1.5 trillion in value from the stock market in just two days. Stocks rebounded on Friday, however, amid persistent bets on AI and a shift in rhetoric from Trump that the U.S. could soon reach an agreement with Chinese officials, sending the S&P 500 to its best week since August.

“I think we’re doing very well. I think we’re getting along with China,” Trump said, adding that he believed his planned meeting with Chinese President Xi Jinping in South Korea this month would proceed as planned. Meanwhile, a surge in AI infrastructure spending continued to fuel optimism around technology stocks. Global AI investment is forecast to reach $375 billion this year and surpass $500 billion by 2026, according to UBS, as the industry continues to power a large portion of returns in the market.

Even as the tech trade keeps global stocks in the green, economic disruption and political gridlock continue to loom over the market. Credit concerns arose last week after Zions Bancorp disclosed a $50 million loan write-off and Western Alliance Bank disclosed a lawsuit against a borrower for alleged loan fraud, fueling worries about a potential “cockroach” effect of more problems in the market. Separately, the federal government is entering into its fourth week of a shutdown after Congress failed to pass appropriations for the 2026 fiscal year. The stalemate over federal spending, foreign aid and health care subsidies has resulted in the delays of key economic data.

That leaves the Fed in a difficult position as it grapples with limited information ahead of its October 28-29 meeting, where policymakers will decide on another potential 25-basis-point cut to interest rates. At a National Association for Business Economics conference in Philadelphia on Tuesday, the U.S. central bank Chair Jerome Powell said that policymakers will take a “meeting-by-meeting” approach to rate cuts as they look to balance a softening labor market and above-target inflation.

Nevertheless, Powell seemingly appears to be prioritizing the labor market over inflation for the time being. “While official employment data for September [is] delayed, available evidence suggests that both layoffs and hiring remain low and that both households’ perceptions of job availability and firms’ perceptions of hiring difficulty continue their downward trajectories,” he said.

“Available data and surveys continue to show that goods price increases primarily reflect tariffs rather than broader inflationary pressures. Consistent with these effects, near-term inflation expectations have generally increased this year, while most longer-term expectation measures remain aligned with our 2 percent goal,” he added, noting that 12-month core personal consumption expenditures inflation reached 2.9 percent in August, up slightly year over year as higher core goods inflation has outpaced housing services disinflation.

The Fed’s latest Beige Book, which will be used as a key decision-making tool at its upcoming meeting, provided further evidence of the “low hire, low fire” environment Powell described, pointing to “hiring chill” as businesses trim headcount through attrition and layoffs rather than actively hiring. Inflation also continues to be a concern, driven by rising input costs, particularly those influenced by tariffs.

This likely helped increase rate cut expectations as investors wagered that the Fed will opt to stimulate the cooling labor market by lowering the cost for businesses and consumers to borrow and spend. The market is pricing in a 100 percent chance of a 25-basis-point cut later this month as well as another one in December.

Also fueling rate cut expectations, Powell indicated on Tuesday that the Fed could soon be ending its quantitative tightening program, which would reduce the central bank’s balance sheet and shore up further liquidity in the market. The Fed’s reserves have once again sunk below $3 trillion, meaning that any further tightening could result in a strain on the market similar to what occurred in September 2019. As the Fed moves to inject more liquidity into the financial system, this could signal the potential for further rate cuts as financial conditions ideally ease, allowing the central bank to shift its focus to the weakening labor market.

This latest indication from Powell was followed by comments from Fed Governor Christopher Waller on Thursday that he would back another rate cut this month while cautioning that the path beyond that was uncertain amid the current lack of data.

Elsewhere, consumer spending has emerged as a bright spot in recent months even as inflation fears have risen and the labor market has weakened. Whether this pattern of resilient spending continues could be a significant determinant in how the Fed approaches monetary policy going forward. “[You] do have a bit of a tension there between the labor market data that we see, very low levels of job creation, and yet people are spending. So economic activity is strong. And ... we’re going to have to see how that plays out,” said Powell, adding that stronger economic activity would support a healthier labor market.

With certain pieces of the economic puzzle still missing amid the shutdown, it’s impossible to fully predict where markets are headed. The good news is that Northwestern Mutual crafts its investment strategy around a vast mosaic of data to prepare for an even wider range of outcomes. As we noted in our most recent Quarterly Market Commentary, expecting—and preparing for—the unexpected is a cornerstone of successful investing.

Wall Street wrap

Beige Book fuels rate cut expectations: As discussed, the Fed released its most recent Beige Book on October 15. The document relayed little change in overall economic activity, with three districts reporting modest growth, five reporting no change and four noting a slight softening. Key findings included stable employment levels, modest wage growth, and continued, albeit slightly moderated, price increases. The report also noted increased uncertainty surrounding tariffs and the government shutdown, reflecting a bifurcated economy in which higher-income consumers are doing the heavy lifting amid a slowing labor market and an increased risk of rising price pressures.

Consumer spending, particularly on retail goods, inched down in recent weeks, while spending by higher-income individuals on luxury travel and accommodation was reportedly strong. Several reports highlighted that lower- and middle-income households continued to seek discounts and promotions in the face of rising prices and elevated economic uncertainty.

Employment levels remained widely stable with muted demand, but many employers are reducing headcounts through layoffs and attrition due to weaker demand and economic uncertainty, increasing bets that the Fed will prioritize the cooling labor market with rate cuts at next week’s meeting.

Wages grew modestly, though cost pressures intensified in some areas; and hiring, when it occurred, often favored temporary workers. Labor supply was strained in some sectors, such as hospitality and construction, in several districts, partly due to recent immigration policy changes.

Imperfect jobs data reinforces ‘low fire, low hire’ climate: While the U.S. Department of Labor has not published its weekly jobs report since September 25 due to the government shutdown, it did publish downloadable data for most states. An analysis by Bloomberg News, which adjusted the raw figures using pre-released weekly seasonal factors data from the U.S. Bureau of Labor Statistics (BLS), found that applications for U.S. unemployment fell to roughly 215,000 for the week ended October 11 from an estimated 234,000 the week prior.

Another labor indicator in the absence of federal jobs data is a report from Indeed, which reflected a highly competitive holiday season on the horizon. Job seeker interest in seasonal work was up 27 percent year over year at the end of September and 50 percent above 2023 levels. Job postings for seasonal work were also up from a year ago but by a far more modest 2.7 percent.

Small business optimism declines amid labor concerns: Optimism among small businesses declined for the first time in three months in September, according to the latest data from the National Federation of Independent Business (NFIB), falling 2 points to 98.8. The index remains above its 52-year average, however. A key reason for the drop was a significant rise in the NFIB’s Uncertainty Index, which rose seven points to 100, its fourth-highest level in over 51 years amid a decrease in uncertainty about financing expectations and planned capital expenditures.

“Optimism among small business owners decreased in September,” said NFIB Chief Economist Bill Dunkelberg. “While most owners evaluate their own business as currently healthy, they are having to manage rising inflationary pressures, slower sales expectations and ongoing labor market challenges. Although uncertainty is high, small business owners remain resilient as they seek to better understand how policy changes will impact their operations.”

The percentage of business owners expecting better business conditions fell 11 points from August to a net seasonally adjusted 23 percent, down from 34 percent the month prior. Supply chain and inflation issues emerged as key issues for small business owners, with 14 percent of small business owners citing inflation as their most pressing problem due to higher input costs. A seasonally adjusted net 24 percent of respondents reported that they raised their average selling prices (a three-point increase from August) and a seasonally adjusted net 31 percent of respondents voiced plans to increase prices over the next three months (a five-point increase from August).

When asked to rate the health of their businesses, 11 percent said excellent (down three points from August), 57 percent said good (up 3 points), 27 percent said fair (unchanged) and 4 percent said poor (unchanged).

Improved sales expectations began to be reflected in the data, with a net negative 7 percent reporting higher sales over the past three months, up from a net negative 9 percent in August.

Builder confidence rises despite affordability challenges: The latest National Association of Home Builders data shows that homebuilder sentiment, measured by the Housing Market Index, increased to 37 in October 2025—a six-month high driven partly by a recent drop in mortgage rates. However, sentiment remains below the 50-point threshold, suggesting that market challenges persist. Builders are using more sales incentives, with the average price reduction holding at 6 percent in October.

The week ahead

Thursday: The National Association of Realtors will release existing home sales for September at 10:00 a.m. EST. U.S. existing home sales rose to a seasonally adjusted annual rate of 800,000, the fastest pace since 2022, following the Fed’s move to cut interest rates. We’ll be monitoring to see whether this trend has continued as mortgage rates have fallen, and a lack of existing homes on the market pushed buyers toward new home purchases.

Friday: The BLS is unlikely to publish its weekly jobs report next week amid the government shutdown. However, the U.S. Labor Department will reconvene staff to work on its much-awaited consumer price index inflation report, according to news reports, slated to be published 8:30 a.m. EDT on October 24—nine days after it was originally scheduled.

Flash Services, Manufacturing, and Global Composite Purchasing Managers’ Index data from S&P Global is also scheduled for Friday morning, which will provide key insights into economic activity, employment and inflation trends in October. Last month’s report showed that U.S. business activity slowed for the second month in a row, with both the manufacturing and service sectors reporting weakened expansions, leading to slower hiring in both categories.We will be watching to see if continued inflationary pressures fueled by tariffs will further drive elevated cost pressures and whether fears of a fading boost from earlier tariff “front-running” will be confirmed in the form of slowing economic growth. On the bright side, business confidence improved in September, reflecting hopes that lower interest rates will help offset tariff uncertainty. We will be watching to see if this trend continues in October.

Finally, The University of Michigan will publish its final October 2025 consumer sentiment index on Friday, which could provide an update on its consumer inflation expectations. The preliminary report released on October 10 was largely unchanged from September, falling from 55.1 to 55.0, reflecting a continued trend of consumers feeling a general lack of optimism about the economy.

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