Growth is slowing, and inflation is easing. More Fed rate cuts are the right response.

By Felix Vezina-Poirier

Weakening economy makes the central bank's December interest-rate decision clearer

Inflation is on Federal Reserve Chair Jerome Powell's radar, but isn't the central bank's biggest concern right now.

The slowdown in job creation since January suggests the economy is not running as hot as growth estimates imply.

Prior to the U.S. government shutdown, the divergence between resilient growth and a slowing labor market became striking. Now, as the shutdown halts the publication of key government statistics, investors are flying partially blind.

But even without fresh official numbers, the latest evidence suggests that U.S. growth estimates are too strong. The divide between reported GDP and weak employment will likely be reconciled by slower growth.

That divergence matters. Whether growth catches down with employment or employment rebounds will determine the path of monetary policy. For the Federal Reserve, a weakening economy argues for further caution.

Macroeconomists face their own version of the chicken-and-egg problem: Is spending driving employment, or is employment driving spending? Normally, it doesn't matter much; the two move together. Spending fuels hiring and income, and income sustains spending in a circular loop.

This year, however, the link has broken. Even before the shutdown, the data showed a split between solid GDP estimates and a stalled labor market. That gap is unlikely to persist. Growth will almost certainly be revised lower, for two reasons. First, growth estimates are often subject to substantial revision. Second, leading indicators already point to softer momentum ahead.

Assessing growth

Think of the economy as a machine. Every machine has a capacity, and how hard it runs relative to that capacity determines its temperature. When the economy runs above capacity, it overheats; wages and prices rise. When it runs too cold, growth, wages and inflation fall, as they often do in recessions.

The Atlanta Fed's GDPNow model currently estimates third-quarter growth at 3.9%, about twice the pace the U.S. economy can sustain without overheating. If growth were truly that strong, we would expect employment to accelerate, not stall. The slowdown in job creation since January suggests the economy is not running as hot as growth estimates imply.

The government shutdown complicates this picture by disrupting the release of "hard data" (direct measures of activity such as employment, spending, production, construction, etc.) typically published by federal agencies. But "soft data," such as business and consumer surveys, remain available. Combined, they give a reasonable view of where the economy stands.

BCA's U.S. growth diffusion index, which aggregates 89 hard and soft indicators and has historically led turning points in GDP, shows growth decelerating below potential. Specifically, the index's hard-data component peaked in April and has slowed ever since. The signal remains the same even when labor variables are excluded.

Meanwhile, the soft data remain subdued. Business surveys consistently cite uncertainty, especially around tariffs, as a key drag on confidence. Although trade deals have been announced, their frequent revisions and the unpredictability of tariff policy continue to weigh on manufacturers and service providers alike.

Inflation and the Fed

The Fed cut its policy rate by another 25 basis points on Wednesday but signaled that a cut at the December meeting is not a foregone conclusion. A key input for whether the central bank cuts again or not hinges on how the growth - employment divide will resolve.

Inflation remains on investors' radar, but for the Fed it has become a secondary concern. Tariffs, not domestic demand, are the main source of upward price pressure.

You might notice that inflation has not been mentioned. That's deliberate. Inflation remains on investors' radar, but for the Fed it has become a secondary concern. Tariffs, not domestic demand, are the main source of price pressures. Monetary policy cannot address that, and tariff-driven inflation is not broadening thus far.

Central bankers view inflation through three lenses: demand, supply and expectations. The demand side has weakened as the labor market stalled. The supply side remains pressured by tariffs but not in a self-reinforcing way as fiscal and monetary conditions are not stimulating demand as they did in 2020 and 2021, when the last supply shock hit the economy.

Market-based inflation expectations remain well-anchored near the Fed's 2% target. CPI swaps, which reflect investors' inflation outlook, show a temporary "tariff bump" over the next year, with one-year swaps near 2.9%. But one-year, one-year forward swaps, which measure expectations for a year starting from now, are at the Fed's inflation target. The same pattern holds in longer-term gauges such as the five-year, five-year forward CPI swap.

Together, these factors paint a picture of softening growth and fading inflationary pressures outside of tariffs, a mix that supports additional easing as the labor market sits uncomfortably close to a tipping point.

Investment implications

Our stance remains neutral on equities, overweight on government bonds and underweight on cash as well as both investment-grade and high-yield credit.

This macro backdrop leaves markets in an uneasy equilibrium. Growth is slowing; inflation is contained; and the Fed is easing, but not urgently. Our stance remains neutral on equities, overweight on government bonds and underweight on cash, as well as both investment-grade and high-yield credit.

Need to Know: Why junk bonds could lower risks in your investment portfolio and even boost returns

At such tight spreads, credit offers a poor reward-to-risk ratio regardless of whether the economy slows or reaccelerates. Equities, by contrast, still have pockets of structural upside thanks to AI and productivity themes that are not directly tied to the business cycle.

For investors, the key is flexibility. If economic growth and momentum deteriorate markedly, underweight stocks. If inflation reaccelerates, underweight both stocks and bonds and shift toward cash and inflation hedges such as commodities. But if the economy slows just enough for monetary policy to save the expansion, current positioning should hold.

Felix Vezina-Poirier is the chief strategist for Daily Insights, BCA Research's global cross-asset strategy service. Follow him on LinkedIn and X.

More: Will the Fed cut interest rates in December? Here's what experts are saying.

Also read: The government shutdown axed the monthly jobs report - but investors can tap these other key sources

-Felix Vezina-Poirier

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10-30-25 1752ET