• The upcoming consumer inflation report for August could influence the Fed’s interest-rate decision at next week’s policy meeting

• Most forecasts point to steady inflation, but rising services-sector costs raise the risk of an upside surprise

• Persistent inflation and mounting fiscal concerns suggest price pressures may remain higher for longer

This Friday’s consumer inflation report will be closely watched on Wall Street for clues about whether the Federal Reserve will raise interest rates at next week’s policy meeting. Although inflation is no longer accelerating, it remains relatively sticky and still well above the Fed’s 2% target, a gap that suggests the central bank may soon resume tightening monetary policy.

Several forecasts indicate that both headline and core measures of the Consumer Price Index (CPI) will remain essentially unchanged. Meanwhile, survey data on prices paid in the services sector – the dominant driver of US economic activity -- suggest that the report could come in hotter than expected.

Here’s a quick rundown of some of the metrics informing expectations for this week’s CPI release:

Cleveland Fed’s CPI nowcast: The regional Fed bank estimates that pricing pressures will remain sticky at current levels, meaning inflation will stay above the Fed’s 2% target. Friday’s August CPI report is projected to hold steady at roughly a 3.4% year-over-year pace, while core CPI is expected to tick down to 2.4%. September nowcasts point to more of the same.

Market-based inflation estimates: A pair of forecasts derived from market data suggests that the headline pace of CPI (red line in the chart below) will decelerate from the mid-3% year-over-year range and move closer to the low-to-mid-2% range in the near term. A similar outlook is implied for core CPI, which excludes volatile food and energy prices. The rationale for using core CPI as a benchmark is that it provides a more reliable measure of the underlying trend, and on that basis these forecasts suggest that the recent gap between headline and core inflation will narrow in the months ahead.

The 5-Year / 5-Year Forward Inflation Expectation Rate reflects investors’ expectations for average inflation over the five-year period that begins five years from now. The indicator currently stands near 2.3%, suggesting that financial markets generally expect long-term inflation to remain relatively close to the Federal Reserve’s 2% target despite ongoing near-term inflation concerns.

The 5-Year Breakeven Inflation Rate is considered a proxy for investors’ expectations for average inflation over the next five years, based on the yield spread between conventional Treasury securities and Treasury Inflation-Protected Securities (TIPS). Currently near 2.4%, the estimate suggests that markets expect inflation to remain above the Fed’s 2% target in the medium term, though well below the elevated inflation rates experienced in recent years.

ISM Services Index – Prices Paid: One sign that Friday’s CPI data could surprise to the upside is the recent upswing in this survey-based measure (blue line in the chart below), which tracks whether firms in the services sector are paying higher or lower prices for goods and services. The index is considered a leading indicator of inflation, and the recent increase points to the possibility that inflation may stay elevated for longer. The August reading of 72.6 marks the highest level in more than three years, well above the neutral 50 threshold, implying an above-average risk that incoming CPI data could come in hotter than expected and perhaps rise further relative to the recent trend.

There are several additional factors that could potentially influence inflation in the months ahead, including the ongoing Iran conflict. A durable peace agreement, if achieved, could provide a meaningful disinflationary impulse by increasing energy exports and lowering oil prices, a key driver of headline inflation metrics. The escalation in fighting this week, however, suggests that peace will remain elusive in the near term.

Even if tensions in the Middle East ease, the bond market is becoming increasingly sensitive to U.S. fiscal risks, which is adding to inflation concerns. The prospects for the federal government to meaningfully address its debt burden remain limited, as political incentives continue to favor higher spending and lower taxes over long-term fiscal restraint. Despite growing concern about rising deficits and debt, there is little evidence that policymakers are prepared to make the difficult fiscal adjustments necessary to materially improve the nation’s long-run outlook.

For now, that leaves investors balancing competing forces: inflation that has stabilized but remains stubbornly above target, and a fiscal backdrop that risks keeping long-term inflation expectations elevated. Friday’s CPI report is unlikely to settle that debate, but it could provide an important signal about whether the economy is moving closer to price stability or entering a period of renewed inflation pressures.

• U.S. recession risk remains low, according to TMC Research’s business‑cycle indicator

• Consumer spending and hiring have cooled, but have not broadly deteriorated

• The hiring slowdown likely reflects labor‑force constraints, not rising business‑cycle risk

Despite a year packed with geopolitical flare‑ups, market tremors, and policy whiplash, a surprising constant has endured: the U.S. economy keeps powering forward. That’s not to say all is well. Several recent developments could turn problematic in the months ahead. Even so, TMC Research’s Recession Probability Indicator (RPI) continues to show low odds that an NBER‑defined contraction is imminent — let alone already underway.

Today’s update echoes RPI’s low‑risk estimates in previous reports this year — in early March (just a few days into the war with Iran) and in mid‑June. With the benefit of hindsight, it’s clear that both estimates were spot‑on. That’s no assurance that today’s low‑risk reading will prevail, but the data suggest that a growth bias continued through late‑August. (RPI aggregates and processes data from three business‑cycle indicators published by regional Fed banks — see here for details.)

Recent economic news has been mixed, highlighting areas to monitor in the months ahead for possible warning signs, including rising Treasury yields, which reflects a mix of concerns, including inflation and the unchecked rise in US government debt.

The recent slowdown in consumer spending also deserves close attention. After accelerating earlier in the year, month‑to‑month growth in personal consumption expenditures downshifted in June and July, rising 0.2% last month — the slowest since January. The softer growth in spending has eased to the lower end of the range for the past year, which suggests that if the deceleration continues it could mark a warning sign for the consumer sector.

Hiring at U.S. companies has also slowed in recent months. Private nonfarm payrolls rose by a modest 30,000 in July, matching the gain in June. The increase marks the slowest pace of job creation since February. Today’s estimate for private payrolls in August via ADP suggests that hiring remained sluggish through last month.

Economists are split on what the recent slowdown in payroll growth actually signals. One camp sees softer job gains as a possible warning for the business cycle, noting that weaker monthly payrolls have historically preceded downturns. But a growing body of research points to a different explanation: labor‑force growth has declined due to sharply lower immigration and an aging population, pushing the breakeven employment growth rate — the number of jobs needed to keep unemployment steady — down, closer to zero. In this view, slower payrolls aren’t necessarily evidence of weakening labor demand but rather a reflection of demographic and immigration‑driven constraints on labor supply.

The bottom line: recession risk remains low, but the margin for error may be narrowing. The next few months won’t just test the expansion — they’ll reveal whether the economy’s resilience still has room to run. If and when economic risks begin to rise, early signs of the shift could potentially show up in the Recession Probability Indicator. For now, at least, business‑cycle risk appears low.

• Warsh’s Jackson Hole debut on Friday approaches as bond‑market anxiety climbs

• Treasury Department comments on market-intervention plans have offered only limited relief for long‑term yields so far

• Markets are watching to see whether Warsh shifts his low‑guidance communication strategy

Federal Reserve Chairman Kevin Warsh has made it clear that he wants to say less about monetary policy compared with his predecessors. He also favors curtailing the Fed’s so-called forward guidance efforts – offering clues about future policy decisions. But at a time of elevated anxiety in the bond market, fueled by concerns about fiscal risk and inflation, investors are wondering if Warsh will be forced to revise his communication preferences.

The question — and the tensions behind it — will be in sharp focus on Friday when Warsh delivers what some observers are billing as his first significant public address at the Fed’s annual Jackson Hole meeting. Although he’s only been leading the central bank for a few months, his speech at the end of this week could be a defining moment for his tenure and cast a long shadow over the bond market.

Expectations for what he may, or may not, say are all over the map. By some accounts, this could be a major event that sets the tone for equities and fixed income for the near term or longer. Other Fed watchers are expecting little if anything new in terms of guidance or insight into Fed policy.

What is clear is that the macro backdrop going into Friday’s speech has become more complex. The US Treasury last week announced a plan to raise buybacks of long-term bonds in an effort to cap if not lower rising Treasury yields. The bond market wasn’t impressed and yields continued to rise by Friday’s close.

As a follow-up, two senior Treasury officials on Monday told CNBC that the nearly $1 trillion Treasury General Account could be used to dramatically ramp up bond purchases.

A few weeks earlier, Treasury took joint action with Japan to raise the value of the yen vs. the dollar in a separate bid to minimize upward pressure on US yields.

Debate rages about whether the government’s interventions in markets will be successful in stabilizing if not lowering long-term yields. There are hints of success as of Tuesday. The 30-year yield, for instance, has pulled back to 5.17% after briefly jumping to nearly 5.34% in intraday trading last week, marking a 19-year high.

The question is how the market will price in the risks that have lifted yields – risks that may not be going away any time soon. Iran-related inflation vis-à-vis energy is one source of concern. Another is ballooning US government debt, which topped $40 trillion this month for the first time. Debt as a percentage of the economy appears to be less stark, but only relative to the spike during Covid.

The main challenge is that government efforts to address the deepening pool of red ink – curtailing spending, raising taxes, or both – remain politically unlikely these days in Washington.

A key issue in the near term is whether Treasury yields at the long end of the curve continue to rise. In that scenario, the Fed may be forced to raise interest rates to persuade the bond market that it’s committed to lowering inflation, which has been running above the 2% target for more than five years. Consumer inflation is running at 3.4% a year through July.

Fed funds futures are still pricing in modest odds in favor of no change for the September 16 policy decision, although the market is expecting at least one hike by the end of the year.

Meanwhile, the one-month Treasury yield has turned up recently, moving out of its recent range, which may signal that bond traders are preparing for policy tightening.

The main event this week is what Warsh says, or doesn’t say, on Friday. Markets will be keenly focused on learning if the Fed chairman uses the annual gathering in Jackson Hole to refine and perhaps update his communications strategy, which had a rocky start in his first two press conferences at the June and July FOMC meetings. Offering minimal insight on his economic and interest rate views, he reasoned that less is more for central bank messaging to markets.

Will he use Friday’s speech to revise that view? Or try to soothe market sentiment with a clear plan to reduce inflation (rather than simply making a general comment that the Fed is committed to price stability, as he has said so far as chairman)?

Alternatively, Warsh may dig in further on his campaign to remove forward guidance and emphasize that markets should price in inflation and economic risks without interference from central bankers. In that case, does the chairman think that bond investors should do the heavy lifting for the Fed and raise yields in reaction to elevated inflation? If so, does the Treasury Department’s latest plans to take a more interventionist approach in markets to lower yields conflict with Warsh’s view of policy framing?

Lots of questions. Perhaps there’ll be some answers on Friday, or not. Either way, the bond market will be watching and reacting.

• Expecting an inheritance tends to change behavior long before the money arrives, new research shows

• Younger adults generally react with the strongest shifts in saving, risk taking, and work habits

• Expecting an inheritance can potentially promote riskier financial choices

No one complains about inheriting money, but new research shows that the prospect of a windfall tends to meaningfully reshape behavior long before any assets arrive. As the authors of “How Inheritance Expectations Shape Financial, Employment, and Family Decisions” explain in an intriguing working paper:

Individuals who expect to receive an inheritance save less, take more financial risks, work fewer hours, put more effort toward personal over career goals, and express greater investment in familial relationships.

The research finds that the effects can be significant even when the expected inheritance is years away. The authors report that expectations alone “can shape economic and social decision-making long before any assets change hands.”

The analysis arrives at a pivotal moment for personal finance. Citing a Cerulli Associates study, the paper notes that the U.S. is on the cusp of the largest intergenerational wealth transfer in history: an estimated $72.6 trillion in inheritances by 2045, including $53 trillion expected to pass from Baby Boomers to their heirs. A key caveat, however, is that longevity, rising healthcare and long-term-care costs, and higher retirement spending may substantially reduce the amount ultimately transferred to heirs. Recent estimates from Visa suggest the net transfer could be closer to $36 trillion after such outflows.

Whatever the final amount, the coming wave of asset transfers is hardly a secret and is already influencing behavior. In new surveys, the paper’s authors report that roughly 18% of respondents have already received an inheritance, and more than half expect one in the future. The chart below, taken from the study, shows a median expected inheritance of $100,000 and an average of $280,000.

Most inheritances may not be enough to dramatically transform long‑term lifestyles. But the anticipation of that money can still reshape financial habits well before the check clears.

The behavioral effects tend to be most pronounced among younger adults, creating concerns for long‑term financial planning. Some may be undersaving on the assumption that future wealth will bail them out. Expectations can create a false sense of security, even though the timing and size of an inheritance are often uncertain.

The study also finds that people expecting an inheritance are generally more willing to borrow, invest aggressively, or take financial risks. Outside of a disciplined investment plan, that shift can be problematic. Believing that a future windfall will cushion mistakes can make risky choices feel safer than they truly are.

Whether or not an inheritance ever arrives, beliefs about future money can quietly—and immediately—shape financial life today. Expectations influence saving habits, risk tolerance, career decisions, and even family relationships.

The paper’s key takeaway for investors: Optimistic or inaccurate expectations about future inheritances can potentially distort financial behavior by reducing saving, encouraging excess risk‑taking, and weakening labor effort, leaving individuals more economically vulnerable.

The authors argue that clearer information on end‑of‑life and long‑term‑care costs, stronger financial literacy programs, improved retirement disclosures, and broader eldercare insurance coverage could help align expectations with reality. Such interventions matter not only for older adults planning their estates, but also for younger people whose financial decisions are already shaped by anticipated wealth.

The inheritance that changes you the most, in short, may be the one you haven’t received yet.

• Consumer inflation cools again, but the bond market isn’t impressed

• Energy prices continue to ease, yet headline inflation stays above 3%

• The Fed’s next move may determine if markets shift their inflation outlook

Consumer inflation ticked lower in July, providing the Federal Reserve with a bit more support for keeping interest rates steady at the upcoming policy meeting in September.

The government’s latest report suggests that the war‑driven surge of inflation is reversing. The drop in the energy component of the Consumer Price Index (CPI) was again a significant source of moderation. But the disinflationary impulse over the past two months remains gradual overall, while the outlook is still uncertain due to the Iran war and ambiguity about prospects for a return to normal for energy exports from the Gulf.

Despite the marginally lower inflation data, the news doesn’t materially change the outlook since the June CPI report. Perhaps that explains why the bond market isn’t particularly impressed with the modestly softer inflation numbers—at least not yet. Meanwhile, Fed funds futures are still pricing in one or more rate hikes by the end of the year.

The market’s reservations aside, a second month of slightly lower year‑over‑year gains for headline and core CPI suggests that the war‑related rise in inflation has peaked and is moving closer to the pre-war trend. Assuming the Middle East crisis remains relatively tame, further declines in inflation are plausible in the months ahead. Whether the bond market is persuaded that the risk has passed, however, remains a work in progress.

The U.S. 30‑year Treasury yield rose in trading yesterday following the release of the CPI data. The long bond, the most inflation‑sensitive maturity, was essentially increased to 5.26%, close to a two‑decade high. The benchmark 10‑year rate also advanced, near its highest level since early 2025.

Fed funds futures are now pricing in a 68% probability that the Fed will leave its target rate unchanged at the September 16 FOMC meeting. For the October and December meetings, by contrast, this market is still anticipating one or two hikes.

Even after a second month of disinflation, TMC Research’s Fed Funds Model continues to estimate that monetary policy has recently shifted to a dovish bias. The model uses several economic and financial factors to estimate a neutral rate. The current profile suggests that a quarter‑point increase is appropriate to remove the passive dovish pivot that emerged after the model’s neutral‑rate estimate rose in late May while the target rate was unchanged.

The Fed’s policymakers have been debating whether inflation will ease without tightening monetary policy. At the July 29 meeting, three of the twelve voting members of the Federal Open Market Committee voted for a rate hike, marking a rare dissent from the majority’s decision to leave rates steady.

The July CPI report offers a bit more support for standing pat, but the debate will likely continue as long as the Iran crisis simmers and headline inflation runs above 3%, which is well above the Fed’s 2% target—a gap that’s prevailed for more than five years.

Several other variables could influence upcoming decisions. One is the strength of the economy, the labor market in particular. U.S. payrolls posted an unexpected drop in July due to cuts in government jobs, although companies continued to hire, albeit at a slow pace. The news boosted confidence that the Fed would forgo rate hikes next month.

Another question is whether the bond market is paying attention to the ongoing rise in the federal budget deficit, which some analysts predict could be a factor that keeps inflation and interest rates higher than they otherwise would be if the fiscal gap were stable or narrowing.

Whatever the logic driving yields, the bond market has yet to embrace the view that inflation risk has peaked and is now on a sustainable course to ease. A key variable that will shape market expectations is the Fed’s upcoming policy decisions, which remain central to determining whether investors should anticipate a prolonged pause in policy, renewed tightening, or a shift toward eventual rate cuts.

• Behavioral biases follow demographic patterns rather than appearing randomly

• Overconfidence and herding are among the most influential drivers of suboptimal investor behavior

• Financial habits formed early in life can leave lasting psychological imprints that shape risk perception well into adulthood

Behavioral risk has been on the financial industry’s radar for decades, but ongoing empirical research continues to refine our understanding of how these biases emerge, who is most susceptible, and why they matter for investors.

A recently published paper in Journal of Risk and Financial Management conducted a systematic review of nearly five dozen studies (published during 2010–2025) and finds that behavioral biases aren’t random or evenly distributed. Instead, they follow clear demographic patterns shaped by age, gender, financial literacy, income, and experience.

It’s not unlike analyzing health risks—such as heart disease or high blood pressure—which are shaped by age, diet, and lifestyle. Similarly, financial “blind spots” tend to follow predictable patterns based on who you are, how much market experience you have, and the early financial habits and security you grew up with.

If you were raised in a household where money was tight or financial hardship was constant, you may be far more likely to carry a strong loss‑aversion bias into adulthood. Even when you have plenty of savings, the instinct to protect capital at all costs can sometimes keep you from taking reasonable risks needed for long‑term growth.

The paper’s efforts to synthesize evidence from several dozen empirical studies don’t just restate the behavioral‑risk challenge—they sharpen it. By pooling results across multiple countries, methodologies, and investor groups, the review confirms that these biases consistently appear in patterned ways, revealing who is most vulnerable and under what conditions.

As the authors note, “overconfidence (31 studies) and herding (26) are the most prevalent biases,” but their intensity and impact vary sharply across investor types. (One of the paper’s tables, partially shown below, highlights the biases associated with the highest numbers of studies used in the analysis.)

A key takeaway is that behavioral tendencies are predictable, profile‑specific, and ultimately manageable—provided investors recognize how these patterns shape their decisions.

A closer review of the paper’s key findings highlights the following points:

Overconfidence and herding dominate investor behavior. Younger, male, and less experienced investors show the strongest tendency toward overconfidence and socially driven herding—patterns that often lead to overtrading, poor diversification, and momentum chasing.

Financial literacy is among the most significant moderators—when it’s high. High literacy reduces most biases. By comparison, moderate literacy increases overconfidence, echoing the Dunning–Kruger effect (a cognitive bias in which people with low or moderate skill in a domain overestimate their ability). Meanwhile, low literacy amplifies availability bias (focusing on the most recent information and data), anchoring (fixating on initial values), and impulsive trading.

Gender and age effects are real—but often disappear once literacy and income are controlled. Women and older investors exhibit more loss aversion and risk aversion, but these differences shrink substantially when financial literacy and socioeconomic factors are included. Behavioral risk appears to be more environmental than innate.

Experience helps—until it doesn’t. Low experience is associated with overconfidence and herding. Moderate experience corresponds to the strongest decision quality. High experience tends to reinforce the disposition effect (selling winning investments too early and holding losers too long) and confirmation bias (favoring information that supports existing beliefs). In short, experience doesn’t eliminate behavioral tendencies—it changes their form, not their likelihood.

Perhaps the most striking finding in the research is the view that behavioral risk is not a universal phenomenon—it’s a demographic pattern. That means advisors may be better positioned to improve outcomes for investors by tailoring communication, coaching, and portfolio design to investor profiles rather than relying on one‑size‑fits‑all behavioral guidance.

The emerging research makes one lesson unmistakably clear: behavioral risk is not a monolithic challenge but a patterned, measurable, and manageable one. Investors bring distinct psychological profiles to the table, and those profiles shape how they perceive risk, process information, and respond to market conditions.

To manage behavioral risk, the solution may not be generic behavioral coaching but targeted interventions—communication calibrated to literacy levels, guidance tailored to experience, and portfolio structures aligned with each investor’s psychological tendencies.

• Investors routinely underperform their own portfolios because behavior, not market returns, drives results

• Strengthening financial literacy is a highly reliable way to shrink the behavior gap

• Professional guidance can help investors stay disciplined when emotions threaten long‑term performance

Predicting financial markets is tough, especially in the short term, but the behavioral habits of the average investor are remarkably consistent in reducing performance. Fortunately, there’s a straightforward fix for some of the biggest behavioral-risk challenges: strengthen investment literacy.

Identifying the problem is relatively straightforward: reacting emotionally to market volatility, for example, can lead investors to panic and make poor decisions. Where things get tricky is adjusting behavior in ways that actually support long‑term financial objectives.

But there’s no debate about the underlying issue. Numerous studies over the years point to an ongoing and uncomfortable truth: investors consistently underperform the very investments they hold.

The issue isn’t flawed portfolio design, which is relatively easy to resolve, particularly for the most-misguided investors. But even the best‑constructed investment strategy will suffer if erratic and ill-advised behavior creates a gap between a portfolio’s return and the lower performance investors actually earn due to poor decisions.

DALBAR, Inc. has been quantifying this so‑called behavior gap for decades. Although the investor penalty rises and falls in any given year, it’s reliably persistent. For 2024, the consultancy reports the “second largest performance gap of the past decade,” with the average equity investor trailing the S&P 500 by more than eight percentage points. The gap narrowed sharply to 72 basis points in 2025, but the average investor still lagged the market.

The behavior gap is also conspicuous for fixed‑income investors, widening to nearly five percentage points in 2025.

Morningstar’s research finds similar results. A recent review of the data reports: “Over the past 10 years, the average dollar invested in US mutual funds and exchange‑traded funds earned 1.2% less per year than what those funds returned during the same period.”

Closing the gap — if not outperforming — is the goal, and the first step is recognizing that behavior is usually far more important than investment selection on average. A recent study by an independent financial researcher underscores how costly emotional decision‑making can be.

“The typical investor suffered a loss of more than 50% of their investment potential because of their own emotional choices rather than market downturns or high costs or wrong investment choices,” advises “Beyond Alpha: Why Financial Education and Behavioral Discipline Outperform Investment Selection in Long‑Term Wealth Management.”

Using DALBAR data, the author adds: “This is not an anomaly. It is the norm.”

Another study a few years ago found that financial literacy is the lowest among the young, based on testing on three questions related to interest, inflation, and risk. “Only 14% of those under age 35 answered all three questions correctly,” according to the FINRA Foundation’s 2021 National Financial Capability Study. “Young people’s financial literacy knowledge lags that of older adults. Nevertheless, less than half of those 66 and older were able to correctly answer the Big Three.”

Focusing on financial education as a solution should be the new norm, the “Beyond Alpha” paper concludes. While this advice has always been true, it matters more than ever for several reasons. One is the surge in the Great Wealth Transfer — an estimated $84 trillion moving from Baby Boomers to younger generations in the years ahead.

Three additional factors raise the stakes for developing financial literacy, according to the study:

• Investor demographics are shifting: Women, Millennials, Gen Z, and growing numbers of minority investors are accumulating more wealth, yet many still face gaps in financial knowledge and access to quality guidance.

• Traditional portfolio management is increasingly commoditized: Low‑cost index funds and other innovations have erased cost and access advantages, making behavioral coaching and client education the true differentiators.

• Regulations are raising the bar: Fiduciary standards increasingly emphasize delivering maximum client value, and evidence suggests behavioral coaching can help meet that requirement — meaning advisors who ignore it may risk falling short of evolving regulatory expectations.

Changing human behavior may be challenging, but the benefits of enhancing financial literacy have been shown to improve investment outcomes. A 2014 study in the Journal of Economic Literature found that taking the time to improve financial savvy leads to smarter long‑term decisions and stronger returns.

Not every investor has the time or inclination to self‑educate on the finer points of managing behavioral risk — and that’s exactly where professional guidance becomes invaluable. A skilled advisor can help an investor bridge the gap between good intentions and disciplined execution, potentially turning financial knowledge into lasting financial results.

One of the best financial moves you can make isn’t outsmarting Wall Street—it’s using financial literacy to outsmart your own instincts.

• The 10‑year yield is near the top of its recent range, raising pressure for stocks

• Relatively elevated “risk‑free” Treasury yields are tougher competition for equities

• The latest rise in rates tilts the near‑term risk outlook for stocks toward caution

The 10‑year Treasury has rebounded to the upper edge of its recent range, keeping rate pressure front and center for equity sentiment. Stocks remain steady near record highs, driven by expectations that investment in artificial intelligence and tech will continue to provide earnings support. Yet the benchmark Treasury yield’s elevated level leaves the market waiting for the next catalyst—whether fresh inflation data, a shift in Fed expectations, or a geopolitical jolt—to determine if rates continue to move higher or begin to ease and give risk assets some breathing room.

Treasury yields are one of many factors that shape how Wall Street weighs the near‑term outlook for stocks versus bonds, but relatively extreme levels in bond‑market rates vs. the recent past can resonate. When the 10‑year rises, “risk‑free” income looks more attractive, making bonds a stronger competitor to equities. When yields fall, the allure eases, arguably pushing investors toward stocks. In effect, the 10‑year can act as a signal for when conditions appear attractive for leaning into growth (equities) or shifting toward safety (bonds).

The relationship isn’t perfect, but it does tend to rhyme through time. One way to monitor the link between the asset classes is to track the 10‑year yield in terms of its current level vs. its trailing 200‑day window. History suggests that when the benchmark rate’s relative valuation is elevated, the increase implies that the potential for equity volatility may rise. That dynamic was highlighted by TMC Research in previous updates – in mid-February 2025, for example, which showed the indicator approaching levels that have historically aligned with a more cautious equity backdrop.

On that basis, the recent run‑up in the 10‑year yield, in both absolute and relative terms, could be a new headwind for stocks. Equities tend to outperform bonds by a wide margin in the long run. But the periodic opportunity in Treasuries to earn a relatively high share of the long‑term return that stocks typically deliver—while taking far less risk—creates robust competition. When investors can lock in a strong, “risk‑free” payout, the appeal of taking on stock‑market volatility diminishes, if only on the margins.

Bonds are never a replacement for stocks, especially when designing an asset‑allocation strategy for medium‑ to long‑term horizons. But as the chart above suggests, the expected risk for stocks in the near term is not static; it ebbs and flows for a variety of reasons.

One is the degree of influence the bond market exerts through current yield, which can be “locked in” by buying and holding an individual fixed‑income security to maturity. Based on the chart above, the case for viewing the latest rise in the 10‑year as a meaningful, if still debatable, challenge to equity sentiment appears to be strengthening.

• The Federal Reserve faces crosscurrents as geopolitical shocks and fiscal strain threaten to reignite inflation

• Diverging inflation gauges blur the policy signal just as decisions grow more consequential

• Markets are split, with some hinting at tightening while others still reflect caution

The outlook for the Federal Reserve’s mandate to control inflation isn’t getting any easier.

The Middle East conflict is escalating again, creating new shipping bottlenecks for energy exports from the region, which could delay—and possibly reverse—the recent disinflationary impulse in the U.S. economy that had appeared set to soften pressure on the Fed to raise interest rates.

Another source of uncertainty is the government’s persistently large fiscal deficit, which risks becoming inflationary as heavy borrowing keeps upward pressure on demand, interest rates, and the overall price level.

Adding complexity to the outlook is the government’s plan to revise how the Personal Consumption Expenditures (PCE) Price Index—the Fed’s preferred inflation gauge—is calculated starting with the September report. The upcoming methodology change reflects the reasonable view that spending patterns and the structure of the modern economy have shifted enough that the index needs updated weights and improved measurement to give policymakers a clearer read on underlying inflation pressures. Nonetheless, the adjustment could be viewed as controversial at a time when current inflation readings remain well above the Fed’s target and rate hikes may be near.

Fed funds futures continue to price in high odds that the central bank will leave its target rate unchanged at next week’s policy meeting (July 29). By year-end, however, futures anticipate one or more hikes.

TMC Research’s Fed Funds Model suggests that policy has recently shifted to a modestly dovish stance, crossing into that terrain in May for the first time in more than three years. The switch implies a case for lifting the current 3.50%–3.75% target range to maintain a neutral stance that balances the Fed’s goal of keeping inflation steady or pushing it lower while providing the economy with sufficient liquidity to sustain a growth bias.

Achieving the central bank’s dual mandate—minimizing inflation and maximizing employment—is always tricky, and may be particularly difficult for the remainder of the year. Inflation is being pushed around by forces largely beyond the influence of monetary policy—renewed Middle East conflict, energy‑supply risks, shipping disruptions, and persistent fiscal deficits—while the labor market remains firm enough to resist cooling. That combination leaves the Fed trying to restrain price pressures without derailing employment, a balancing act made tougher by shocks that policy can’t easily offset.

The Fed is also receiving mixed signals at a challenging moment for policymakers: core PCE’s one‑year rate has been drifting higher, the core Consumer Price Index eased in June, and the 16% Trimmed Mean CPI—a measure Chair Warsh has praised as a cleaner read on underlying inflation—is hovering near the Fed’s 2% target. That divergence muddies the policy picture, forcing officials to decide whether inflation is re‑accelerating or simply settling into a slower, more stable trend.

The bond market has been flirting with the possibility that a Fed rate hike is near. The 2‑year Treasury yield—widely viewed as a market‑based proxy for rate expectations—is trading above 4.2% this week, well above the Fed’s current 3.50%–3.75% target range, implying that investors expect a hike.

Short‑term market rates, however, suggest that tightening isn’t imminent, per the chart below, which highlights several rates that are sensitive to policy‑bias expectations. A decisive move upward in these rates from current levels could be an early sign that liquidity conditions are shifting to accommodate an increase in the Fed’s target rate, proxied by the Effective Fed Funds Rate (red line).

Despite the relative calm in the bond and rates markets, the next several policy meetings could be more complicated than usual to navigate. Part of the challenge is a rising skepticism about the accuracy of economic data—doubt that could be amplified by the government’s planned September change in the PCE inflation methodology.

As former Federal Reserve and White House economist Claudia Sahm wrote last week: “If we do not all agree on the yardstick, then a commitment to price stability is nearly meaningless.”

Fed Chairman Warsh has made several hawkish comments since taking the helm in May. In what may become his signature statement, he emphasized that the Fed would have “no tolerance” for persistently elevated inflation above the 2% target.

Yet some critics charge that he has not outlined how he intends to achieve that goal or whether PCE remains the formal yardstick. The Fed chief has criticized core PCE in Senate testimony as a “rough swag as to what was going on” with prices. “We don’t have to do a rough swag any more.”

His gray‑zone commentary concerns some Fed watchers, who argue that the lack of clarity, intentional or not, may make the central bank’s job tougher as it tries to keep inflation near its target.

Sahm asserts that “Redefining inflation is not the way to achieve price stability.”

The crucial question is whether the bond market will interpret the shifting metrics, mixed signals, and geopolitical shocks as a sign that the Fed’s inflation‑fighting credibility is strengthening—or slipping.

• Investors often flee to safety fast, but crawl back to risk slowly

• Fear tends to drive the trade, not math

• Staying safe too long can cost you the recovery

One of the biggest threats to long‑term investing isn’t a volatile market or high fees, but it can be the way our brain reacts to them.

While we like to think of ourselves as rational, humans are hardwired to react emotionally to financial highs and lows — a vulnerability generally known as behavioral risk. When investors panic-sell during market drops or chase hyped-up trends at their peak, they run the risk of locking in losses and dragging down their returns. Ultimately, managing your own behavior and sticking to a plan can matter far more to your lifetime wealth than trying to outsmart the stock market.

There are various dimensions of behavioral risk, and perhaps the facet with the highest stakes arises during periods of extreme market volatility. A recent study adds crucial insight by demonstrating that investor behavior is itself highly volatile during periods when “safety” is in high demand. The analysis highlights several pitfalls that emerge when market stress is elevated, according to “Risk Perception under Uncertainty: A Behavioral Analysis of Safe-Haven Asset Return Responses,” published last month in the Journal of Research in Economics, Politics & Finance.

One of the study’s main findings is that investor risk is not a static, mathematical formula, but a dynamic, psychological reaction. That contrasts with traditional finance models, which treat risk as a two-way street and assume, for instance, that when market uncertainty rises by 10%, safe-haven prices go up by a matching 10%, and when uncertainty falls, they drop by the same degree. This paper shows that investor behavior is, in fact, highly asymmetric (unequal).

The research finds evidence of what might be called a panic premium, the extra cost added to certain assets during times of widespread fear or uncertainty. Markets can react violently to bad news, causing safe-haven prices to jump quickly. But when the dust settles, those prices don’t come down nearly as fast, because human fear lingers. If you buy during the panic, you may end up locked into an inflated price.

Investors react far more aggressively and persistently to increases in uncertainty — driven by loss aversion and panic — than they do to decreases in uncertainty. When a crisis hits, investors overreact and pile into safe assets, driving prices up rapidly.

The flip side of this behavioral pattern is that the recovery is slow. When the crisis ends and uncertainty falls, investors do not sell off their safe havens at the same speed. Fear lingers, causing safe-haven prices to remain elevated long after the actual danger has passed.

If you buy defensive assets during a crash, you probably aren’t solving a calculated math problem to optimize your expected payoff. Rather, you’re paying a premium for a “psychological anchor” that soothes your anxiety and stops the emotional pain of watching your portfolio drop. Contrast that with the standard financial-textbook assumption that investors are rational and will make logical, cold-blooded decisions, even when a portfolio has quickly lost 20%. In reality, biology takes over.

One lesson is to build a structured portfolio before the storm hits — often a more reliable way to protect yourself from your own inevitable, fear-driven decisions. Putting clear rules in place on how a portfolio will be managed through time — before a crisis strikes — is also prudent.

As the study notes, “The investment decision of an individual can be affected by psychological variables like uncertainty, anxiety, and fear... The helpfulness of the concept of rationality is limited in times of turmoil.”

This research highlights a subtle but consequential risk for investors: the loss-averse instinct that sends capital rushing into safe havens during spikes in market volatility, policy uncertainty, or geopolitical tension does not reverse with equal speed once conditions calm down. In short, investors tend to de-risk fast but re-risk slowly, if at all.

For an investment portfolio, this behavioral lag can translate into a tangible opportunity cost: capital that stays parked defensively out of lingering anxiety, rather than being redeployed once risk genuinely subsides, misses out on the recovery and growth phases of the market cycle. Over time, this pattern of overstaying in “safety” can quietly erode long-run returns relative to a more risk-tolerant, timely reallocation strategy — turning a rational, protective impulse in the moment into a source of underperformance in the long run.

None of this means that periodic adjustments to risk exposure is inherently a mistake. Tilting toward a more defensive asset allocation during periods of genuine stress is often a sound and necessary part of managing a portfolio through time. The problem isn’t the instinct to seek safety; it’s the tendency to stay there long after the original rationale has faded.

The real takeaway is that risk management works best as a deliberate, pre-planned process with well-designed rules rather than a reactive one driven by lingering fear. Investors who build a sound framework in advance — with defined triggers for both scaling into and out of safe havens — are better positioned to manage risk through time without falling into the trap of chronic overcaution.

Done well, risk management remains one of the most valuable tools an investor has; done reactively, it can quietly become one of the costliest.

• Passive tends to work inside an asset class, while customizing may matter more for investing in several markets

• Investors face finite time horizons and various behavioral challenges

• Risk‑tuned asset allocation could potentially deliver steadier, more “livable” outcomes

The case for indexing is well‑established, supported by academic and empirical research. But while there’s a strong case for passive investing within an asset class, in our view the argument weakens—if not breaks down—when the focus turns to multi‑asset‑class portfolio strategies.

There are several reasons why asset allocation may reasonably be customized, which is to say intentionally designed to deviate from a passively managed, market‑value‑weighted strategy. One of the more compelling factors: the time horizon for a passive asset‑allocation strategy is optimal, in theory, only for the average investor with an infinite time horizon. No individual investor matches that profile, which lays the groundwork for customizing asset allocation for a real‑world portfolio.

The apparent contradiction between favoring passive strategies within an asset class vs. customizing strategies that use several asset classes isn’t inconsistent upon closer inspection. Markets are relatively efficient (or at least hard to beat) within a particular asset class. The most compelling example is large‑cap U.S. stocks, as S&P Global’s periodic updates remind. A recent update reports:

Of all active large‑cap U.S. equity funds measured, 79% underperformed the S&P 500 in 2025, worse than the 65% rate observed in 2024 and the fourth‑worst year for active large‑cap managers over the 25‑year history of the SPIVA Scorecards.

Using index funds to capture asset class beta is defensible, if not compelling, but the rationale doesn’t always transfer to asset allocation for reasons related to risk management, particularly for individual investors. Saving for retirement, planning for college expenses, and similar goals are bound up with finite time horizons, even if they run for several decades. That’s a mismatch with a market‑value‑weighted asset‑allocation strategy that, in theory, would hold all investable asset classes and never rebalance.

A passive asset‑allocation strategy may be tough to beat over very long stretches of time, but investors have financial needs in the short term that require liquidating investments. There are also behavioral factors in play that raise the value of “livability” in portfolios. The short‑run volatility that a passively managed asset‑allocation strategy may exhibit could be a bridge too far for some—perhaps many—individuals. The ideal investment plan for the long haul is worthless if market volatility triggers a flight‑to‑safety decision during the depths of a bear market.

Managing risk, in other words, is necessary, but in our view, it tends to work best at the asset‑allocation level. One reason: while markets tend to be efficient within asset classes—which implies indexing is preferable in this context—cross‑asset‑class efficiency is often substantially lower.

Some research hints at the possibility that trading frictions can be higher and capital flows slower between asset classes at certain times compared with transactions within asset classes. One explanatory theory is that most market participants are highly specialized in a given asset class, in contrast to the smaller group of generalists who focus on reallocating capital across markets, such as stocks, bonds, real estate and commodities.

A contributing factor may be related to various behavioral biases and industry constraints. For instance, home bias—a tendency to invest a disproportionately high share of a portfolio in one’s domestic market—may play a role. Consider that U.S. equities in 2024 represented nearly half of global stock‑market capitalization, according to SIFMA, a financial‑industry trade group. Tracking a passive mix of global stocks translates to a 50/50 allocation. Most U.S.‑based investors with international equity exposure are probably holding substantially lower levels of foreign stocks.

Capital bottlenecks could also play a role—capital flows across borders, although streamlined in recent years, are still less efficient than money management within borders.

Another dimension is complex macro dynamics, including geopolitical risk and manipulated foreign‑exchange values, which also reduce cross‑border and cross‑asset allocation efficiency relative to single asset classes within a country. But therein lies a degree of opportunity, since lower market efficiency raises the potential for mining portfolio alpha through tactical asset allocation and related strategies.

Keep in mind that alpha can be defined in terms of risk‑adjusted return. That’s a key point, since individuals don’t have 50‑year investment windows. Retirement dates, college funding, home purchases, and health‑related expenses create fixed deadlines. A deep drawdown close to one of those deadlines can permanently impair outcomes because there isn’t enough time for markets to recover.

An added complication: humans are not rational compounding machines. They are emotional, pattern‑seeking, and loss‑averse. Risk management can reduce the emotional triggers that activate these biases. Shallower drawdowns, for example, mean fewer panic decisions. More stable return paths reduce temptations to chase performance.

Customizing an asset‑allocation strategy using low‑cost index funds tends to be the more effective path for managing risk and designing portfolios that are “livable,” while providing investment solutions that match an investor’s goals, risk tolerance, and other factors. This approach may, over the very long run, trail a true passive asset allocation that holds all investable markets in proportion to their market values. But as a practical compromise for real‑world investing, it’s a reasonable—if not compelling—concession to potentially deliver more stable outcomes for investors who must balance growth with the practical realities of time, behavior, and risk.

• Lofty stock market valuations leave little room for error if AI earnings don’t keep delivering

• The S&P 500’s AI tailwind is strong, but the headwinds may be getting stronger

• AI is still powering the S&P 500, but China’s fast‑moving challengers are tightening the competitive screws

The US stock market has been on a wild ride this year, but the Middle East conflict has yet to dent bullish expectations. A key reason: enthusiasm for artificial intelligence (AI) as a business model. Wall Street projects this tech story will lift earnings at a robust rate well into the future.

The combination of AI‑related infrastructure spending and opportunities for selling AI services to businesses and consumers has fueled expectations that this leading edge of technology development will continue to drive corporate bottom lines to new heights in the near term.

FactSet estimates that that year-over-year earnings growth for S&P 500 companies will rise more than 23% in Q2, which would mark a second-straight quarter of growth at a 20%-plus pace. The forecast also reflects a strong improvement over the roughly 15% earnings growth that was expected when the year began, according to LSEG IBES data.

Despite Wall Street’s cheery outlook, the bull run isn’t without risk. One is the burgeoning threat of Chinese AI firms, which are charging far less than their American competitors. Models maintained by leading US firms, such as Anthropic and OpenAI, reportedly have an edge over systems offered by companies in China, but the gap is expected to narrow. Meantime, demand for China‑based systems is starting to gain traction. That persuades some analysts to argue that it’s just a matter of time before competitive pressures accelerate and potentially create stronger headwinds for AI‑driven earnings growth in the US.

Some analysts are beginning to question whether cash‑flow and earnings forecasts based on AI are too optimistic, given the rise of China‑based competition. Although no one can confidently predict how this business war will evolve, it’s clear that the crucial engine of optimism for the S&P 500 is increasingly bound up with assumptions that AI will do the heavy lifting to keep the earnings train rolling.

Buoyant earnings forecasts that hit the mark may become increasingly necessary at a time of elevated market valuations, which reflect assumptions that a best‑case scenario will prevail. A widely followed measure of price multiples for stocks is close to a record high. The Cyclically Adjusted PE Ratio (CAPE Ratio) is estimated at nearly 42 for July, near the 150‑year peak set during the dot‑com bubble in 1999–2000.

The pushback is that AI is generating earnings, whereas the tech bubble of a quarter century ago was largely driven by expectations—many of which failed to materialize in a timely manner. Fair point. But if the market is fully valued, if not excessively so (as some pundits argue), which implies relatively low expected returns, there’s little wiggle room for disappointment.

On that note, our update of expected return for the S&P 500 for the ten years ahead remains modest. In particular, the TMC Research average estimate for several models is a 5.6% annualized return for stocks – unchanged from our previous update in February, and still far below the market’s current trailing 13%-plus annualized rise over the past decade. As the chart below reminds, performance on a rolling ten-year basis has rarely been stronger.

As always, the standard caveat applies when attempting to divine the future. Accordingly, take this and all forecasts with a grain of salt. However, the hefty gap between expected and actual performance suggests things might soon snap back to reality in some degree. It all comes down to the classic question: Is it really different this time? If so, why?

The future isn’t bound by the past, and perhaps AI is a genuine game-changer. But with the market outperforming so dramatically, the burden of proof is increasingly on the bulls to explain and rationalize why high returns and stellar earnings reports will persist.

Here’s a quick review of each of the five models used to generate the forecasts above:

CAPE Ratio Model: this stock market valuation indicator, maintained by Professor Robert Shiller, is calculated using real earnings per share for the S&P 500 based on a rolling 10-year window. TMC Research uses the CAPE ratio to generate an implied return for the stock market.

Earnings Yield Model: the stock market’s implied ex ante performance is derived from the S&P 500’s earning yield, defined as the inverse of the price-to-earnings ratio.

ARIMA Model: In contrast with the two models above, which use valuation to infer future return, this estimate uses statistical analysis to generate a forecast. An autoregressive integrated moving average (ARIMA) model is a type of regression analysis that’s run on rolling window of the market’s return history to estimate future results.

Bayesian Model: This statistical model uses lags as a basis for updating so-called “prior beliefs” on a rolling basis to estimate the effects of previous effects on the S&P 500 to forecast return.

Average Historical Return Model: This naïve estimate is a simple average of all the rolling 10-year returns since 1960.

• Small caps are outperforming in 2026, fueled by stronger earnings expectations and bargain valuations.

• AI‑linked holdings and a resilient U.S. economy are adding momentum to the rally.

• The Fed tailwind could vanish quickly if the Iran crisis reignites inflation and forces renewed tightening.

Small-cap stocks are outperforming large caps and the broad market this year. Will it last?

It’s a reasonable question, given the multiple false starts in recent years when small caps took the lead only to trail soon after and yield to large caps. Analysts say this time could be different, citing several favorable tailwinds.

One possible driver is implied via performance history, which suggests small caps may be overdue for a run of outperformance after trailing larger firms for much of the past five years.

Investors in lesser-capitalization stocks are hoping for a rotation in leadership comparable to the roughly six-year runs of small-cap dominance in 2000–2006 and 2008–2013, based on the ratio for two ETFs: SPDR S&P 500 (SPY), which is heavily weighted in large caps, vs. iShares Core S&P Small-Cap ETF (IJR). As shown in the chart below, when this ratio is rising, large caps are outperforming; when the ratio falls, small caps are winning.

Keep in mind that outperformance sometimes means losing less. But so far in 2026, the small-cap edge is strong in both relative and absolute terms. The iShares Core S&P Small-Cap ETF (IJR) is up nearly 23% this year through July 6, according to Morningstar.com. That’s more than double the advance for the SPDR S&P 500 ETF (SPY).

Analysts cite several factors for the tailwind in small caps that could keep the party going, starting with a bullish outlook for earnings. Estimates for 2027 for the S&P 600, a small-cap index, have improved sharply relative to this year and 2025, according to Yardeni.com, a research shop. The forecasts also compare favorably vs. the outlook for large cap earnings (S&P 500).

Another driver, which may be underappreciated: small-cap indexes hold semiconductors and other stocks linked to artificial intelligence and the recent surge in related infrastructure spending. As one example, Morningstar reports that the tech sector recently represented around 15% of holdings for the iShares Core S&P Small-Cap ETF (IJR), which includes MaxLinear (MXL), a maker of radio-frequency and mixed-signal chips that has jumped as cloud platforms and semiconductor firms accelerate buildouts for AI-driven connectivity.

Comparatively attractive valuations for small caps are also supportive. In contrast with the big-cap AI- and tech-driven large-cap space, which have posted lofty price-to-earnings ratios, small-cap valuations started the year at a steep bargain by comparison -- approaching the lowest levels relative to large-caps in decades, according to one estimate.

A resilient US economy is also a factor. Strategists at Goldman Sachs advise that the business cycle “is usually the most important macro driver of small-cap US equities,” according to a research note published last week.

The path ahead for inflation could be a risk factor due to conflict with Iran, which has increased pricing pressure through a surge in energy costs. Although stocks generally can come under pressure if inflation heats up and the Federal Reserve responds by raising interest rates, small caps tend fare worse. One reason: Small‑cap firms are generally less profitable and more credit‑dependent, making them especially vulnerable to a surge in borrowing costs because they pay higher rates, face shorter‑term loans, and are exposed to greater interest‑rate volatility, strategists at Charles Schwab observe.

Relative calm in the Middle East, however, suggests inflation may have peaked. The Cleveland Fed’s latest nowcast show the year-over-year change the Consumer Price Index is expected to ease for the first time since the war began. The question is whether the return of military strikes this week threatens to renew inflation’s pulse.

The futures market is pricing in moderately high odds that the Federal Reserve will keep its target interest rate unchanged at the next policy meeting on July 29. A rate hike in September, however, is considered likely.

The recent tailwind from a steady Fed could prove fleeting if the Iran crisis escalates and energy prices surge again, rekindling inflation pressures and potentially forcing policymakers back into a tightening mode. In that scenario, small caps could once again take a back seat to large caps. For now, though, the small‑cap edge remains intact as 2026 enters its second half.

• Trimmed‑mean inflation is substantially cooler than standard price measures

• Markets are expecting rate hikes despite calmer trimmed‑mean readings

• The Fed faces mixed signals at a pivotal policy moment

The latest inflation numbers aren’t especially encouraging for Fed Chair Kevin Warsh, who emphasized at his first policy meeting two weeks ago that the central bank “will deliver price stability.” But the new Fed chief is a fan of so‑called trimmed‑mean inflation, which currently reflects a substantially lower, steadier pricing trend. The question is whether this alternative model for tracking inflation will persuade the Fed to delay—if not forgo—rate hikes.

Warsh appears committed to using alternative price measures and seems intent on giving them a larger role in Fed policy decisions. During his Senate confirmation hearing in April, he argued that “the data that’s being used to judge inflation is quite imperfect.” As a solution, he urged the Fed to focus on “trimmed averages” for a clearer, more reliable measure of the “underlying, generalized change in prices in the economy.”

That’s a provocative idea at a time when a leading proxy for the trimmed‑mean inflation rate is running at a pace substantially below the Fed’s standard inflation metrics. Using the latest numbers for May, the one‑year change in the Dallas Fed’s trimmed‑mean core (excluding food and energy) PCE price index is a comparatively tame 2.4%, only modestly above the Fed’s 2% inflation target. By this standard, the Fed can afford to be patient about a future policy pivot.

By contrast, the standard core PCE inflation trend that the Fed has long focused on is considerably hotter, posting a 3.4% increase over the year‑ago level—the highest since late 2023 (green line in chart). Headline PCE, which includes food and energy, is even higher, topping a 4% annual pace through May for the first time in three years (black line).

The trimmed‑mean methodology drops the largest and smallest price changes and calculates inflation from the weighted average of the remaining, more representative items. Supporters say this approach can be superior because it filters out the most volatile monthly price swings, providing a steadier, more accurate real‑time signal of underlying inflation trends and future inflation than traditional core measures, which simply exclude fixed categories like food and energy.

But what sounds encouraging in theory doesn’t always translate into an advantage in practice. As the chart above shows, trimmed‑mean PCE inflation was slow to react to the 2021–2022 inflation surge compared with the standard PCE measures.

When the Fed began raising rates in March 2022, critics charged that policymakers had waited too long, allowing pricing pressure to run higher and last longer than if a hawkish pivot had come earlier. The slow change in trimmed‑mean inflation suggests that relying too heavily on this measure would have left the Fed even further behind in responding to the pandemic‑related inflation spike.

Whatever the flaws or advantages of trimmed‑mean inflation, it isn’t expected to play an outsized role in Fed decisions any time soon. That, at least, is the implied forecast from the Fed funds futures market, which is pricing in rising odds of rate hikes in the near term. For example, the roughly 30% estimated probability of tighter policy at the next FOMC meeting on July 29 climbs to 62% for September. The priced outlook for another hike later in the year has also been edging higher.

Even so, the path ahead for the Fed remains fluid, buffeted by shifting assessments of geopolitical risk in the Middle East and its impact on energy exports—an input that remains central to inflation expectations. The sharp drop in crude oil prices in recent weeks is, for now, holding, a decline that will soon translate into lower headline inflation pressure. The concern is that standard measures of core inflation, regardless of near‑term energy trends, may already be set on a path to rise further and widen the gap over the Fed’s 2% target.

Meanwhile, it’s unclear how much influence the trimmed‑mean data will exert on the Federal Open Market Committee and its upcoming decisions on interest rates.

One thing is certain: Warsh’s preferred inflation gauge may be trimmed—but the debate over its power to shape Fed policy is anything but.

• Fed stance has slipped into a dovish bias as our neutral rate estimate rises

• Rising inflation pushed the model’s neutral rate higher

• Fed funds futures are pricing in higher odds of rate hikes

Fed Chair Kevin Warsh struck a hawkish tone at his debut press conference last week, but the central bank’s policy stance has turned dovish in recent days, according to TMC Research’s Fed model.

For the first time in three years, the Effective Fed Funds Rate has fallen below our estimate of the neutral level of the Fed’s target rate—a gap that suggests monetary policy has shifted to a dovish bias (roughly 40 basis points below neutral as of June 24).

It’s important to understand the mechanics behind the shift. The Effective Fed Funds Rate has been unchanged since the Fed cut rates in December 2025. What has changed is one of the inputs to our model: inflation via the Consumer Price Index. The recent rise in CPI has pushed our estimate of the neutral rate higher.

The key takeaway: the Fed’s policy bias appears to have moved from moderately tight to moderately loose—not because of any new action by the central bank, but because of its lack of action in the wake of hotter prices.

The debate is whether the recent upturn in inflation will prove temporary, which would ease pressure on the Fed to tighten policy through one or more rate hikes. The risk is that stronger pricing pressure persists. If so, the longer the Fed waits to respond, the greater the possibility that inflation becomes more entrenched—forcing the Fed to raise rates higher and keep them elevated longer than would have been necessary with earlier action.

Warsh refrained from offering forward guidance at last week’s meeting, but almost half of the Fed’s members of the Federal Open Market Committee project at least one rate hike by year‑end, and several believe multiple increases may be needed.

Although Warsh has been critical of the Fed’s forward‑guidance efforts—such as publishing rate forecasts by FOMC members—he emphasized that “the Committee will deliver price stability.” He also noted that “inflation has been running well ahead of the Fed’s long‑stated inflation goal of 2%—that’s been going on for more than five years. Persistently high prices are a burden for the American people.”

The uncertainty is whether the Fed will soon raise rates or continue a wait‑and‑see approach that assumes the recent rise in inflation is temporary. The sharp drop in oil prices over the past several weeks—driven by what appears to be an end to the war with Iran—supports the view that headline inflation may have peaked and could soon ease.

Fed funds futures are pricing in roughly a 72% probability that the Fed will leave its target rate unchanged at next month’s FOMC meeting. For September, the probability rises to 87% for either no change or a cut.

The bond market also appears to be giving the Fed more room to be patient, if not implicitly assuming the inflation surge will prove transitory. The 10‑year Treasury yield, for example, has pulled back from its mid‑May spike, trading around 4.40% versus nearly 4.70% a month ago, although the current yield is still up sharply relative to where it began, just below 4.0%, on the eve of the war’s start.

The Fed’s next move is uncertain, but the window for inaction is getting narrower by the day. At some point soon, the inflation data will force a decision, one way or the other.

• Several asset classes beat the S&P 500 during the 2026 drawdown

• Treasuries, commodities, and cash have routinely outperformed the S&P in recent drawdowns

• Cash remained the only asset to post absolute outperformance in every major drawdown since 2007

The recent rise in the correlation between stocks and bonds has sparked debate about assumptions for risk models and the role of asset allocation. The market volatility triggered by the Iran conflict has only sharpened the discussion about what to expect from cross‑asset relationships in the design and management of investment portfolios.

One way to monitor and evaluate asset allocation’s value as a risk-management tool is tracking how markets behave during the steepest drawdowns for U.S. stocks. Last October, TMC Research analyzed the five deepest peak‑to‑trough declines in the S&P 500 Index since 2007 relative to ten markets that, at various times, provide some degree of hedging against sharp losses in U.S. equities. In today’s update, the results of this year’s S&P 500 drawdown are added to the mix.

As shown in the table below, the benefits of a diversified portfolio across asset classes proved valuable once more in the recent stock-market decline. This year’s S&P 500 drawdown was relatively moderate by historical standards—the 11th deepest since 2007, briefly touching a 9.1% loss from the previous peak. Seven of the ten markets listed outperformed U.S. stocks, either in relative or absolute terms, based on a set of proxy ETFs.

The dates shown in the table (reading left to right) indicate the S&P’s peaks and troughs for each drawdown event. This year’s decline (bottom row) cut the S&P by 9.1% before the market recovered.

The assets that fared worse than the S&P 500 during this year’s drawdown: gold (GLD), large‑cap growth stocks (IVW), and emerging‑markets equities (VWO). The best performer during this year’s correction: commodities (DBC), which surged more than 17% during the S&P 500’s slide.

Note, too, that only three asset classes have outperformed the S&P in all six drawdown events listed in the table: Treasuries (IEF), commodities (DBC), and cash (SHV). Although outright gains were recorded in several cases, only cash (SHV) consistently outperformed in absolute terms across all six episodes.

The key lesson from the results above is unchanged from our previous update: diversifying across asset classes remains a useful risk‑management tool. Although the relationships between asset classes aren’t fixed and continue to evolve, the general strategy of holding a global portfolio as a hedge against uncertainty still looks compelling.

History doesn’t offer any guarantees on how assets will perform in the next crisis, but using this year’s stock‑market correction as a guide suggests that maintaining broad, multi‑asset exposure is a powerful tool for navigating an increasingly unstable investment landscape.

• Narratives can move prices, too, influencing investors beyond “normal” market volatility

• Perceived risk can overtake actual risk when narratives dominate

• Hidden narratives can quietly steer investment decisions

Are you reacting to market volatility – or stories about it? Both can potentially steer investors off course from their long‑term financial goals without careful planning, but one is more subtle, and therefore can pose a bigger risk.

So‑called narrative risk comes in many forms, including content from social and mainstream media. That creates a threat that can be especially stealthy for otherwise sound judgment in money management. Consider market volatility: when it strikes, it’s obvious, reflecting a measurable move in asset prices. Sharp drops in the stock market are immediately evident, not to mention expected for anyone who studies financial history in the context of long‑term planning. A carefully designed diversified portfolio, rebalancing rules, and a long time horizon all assume volatility will show up.

By comparison, narratives about market volatility can be more understated and, for some investors, fly under the radar. That’s a problem: if you are not aware of narrative risk, you may not be prepared for it.

Behavioral Traps and Narrative Risk

Recent research highlights the potential for trouble. The power of financial narratives arises from the emotions they generate.

“We find investor emotions are associated with up to 52% of market returns and 67% of market uncertainty during these market crises, and provide general evidence that investor emotional dynamics may be time and context invariant,” advise the authors of “Narrative Emotions and Market Crises,” a study published in the Journal of Behavioral Finance last year.

Another recent study – “Competing Narratives in Financial Markets” – outlines how viral narratives can drive bubbles, crashes, and volatility through opinion dynamics, fueling the possibility that competing stories can create instability even without new economic information. The key takeaway: Viral stories and social media hype can be a bigger factor in changing asset prices compared with a company’s actual financial health. By simulating a digital stock market, the researchers demonstrate that when investors split into opposing groups—like “bulls” who believe a stock will skyrocket vs. “bears” who think it will crash—their social circles turn into echo chambers that fuel massive, unpredictable price swings.

When Narratives Become Market Movers

The lesson for investors is to be alert to herding behavior, a.k.a. FOMO or fear of missing out. When the crowd buys into a stock purely because a certain narrative goes viral, it may create unstable price bubbles that can violently burst the moment the crowd changes its mind.

Some researchers find that market crises are fundamentally psychological events. Because these emotional narrative cycles repeat almost identically across history, sophisticated investors should monitor mainstream financial media narratives not just for “facts,” but as a barometer for collective anxiety or denial. Recognizing when a market is heavily decoupled from fundamentals and driven by narrative‑induced emotions can help investors avoid panic‑selling during crashes or over‑buying during bubbles.

Narrative risk appears to be a growing threat as social media deepens its reach and influence among investors. And unlike traditional volatility, which is visible on a chart, narrative volatility is invisible until it has already shaped behavior. That’s what makes it so hazardous: it doesn’t attack the portfolio first — it attacks the decision maker.

When stories about markets become louder than the markets themselves, investors may start reacting to perceived risk rather than actual risk. A headline that “stocks are plunging” can trigger anxiety even if the underlying move is routine and within a “normal” range. A viral post claiming a stock is “the next big thing” can override years of disciplined planning. In both cases, the narrative (rather than the fundamentals) can become a catalyst—perhaps unconsciously—for action.

For long‑term investors, the implication is clear: managing money requires managing the information ecosystem that surrounds it. That means:

Treating narratives as data. If the emotional tone of financial news is spiking, that’s a signal that collective psychology may be shifting.

Separating noise from signal. Volatility is normal; narrative amplification is optional. Investors who can distinguish between the two are less likely to overreact.

Re‑anchoring to fundamentals. When stories become extreme, returning to earnings, cash flows, valuations, and long‑term goals provides a stabilizing counterweight.

Building behavioral guardrails. Pre‑committed rebalancing rules, automatic contributions, and written investment policies generally help neutralize narrative‑driven impulses.

The bottom line: market volatility tests portfolios, but narrative volatility tests investors. The former is built into every financial plan; the latter can quietly unravel one. In an age when stories spread faster than facts, the real competitive advantage is not predicting the next narrative — it’s refusing to be ruled by it.

• Recession odds stay low as growth outperforms crisis expectations

• TMC’s recession indicator signals resilience, not contraction, despite inflation pressures

• Stronger hiring and firming GDP keep the Fed in wait‑and‑see mode

At the start of the Iran conflict, many analysts expected US economic growth would stumble and recession risk would spike. It was a reasonable view at the time, although TMC Research noted a few days after the war started that our “Recession Probability Indicator (RPI) continues to reflect a low probability that an NBER-defined downturn has started or is imminent.” An update of the numbers suggests more of the same.

More than three months into the Middle East crisis, the American economy still looks resilient. Inflation is an ongoing threat, thanks to the supply-side energy shock that’s lifted prices. But growth has held up better than expected, and the odds appear low that the economy is on the precipice of a material slowdown, much less an outright contraction.

The TMC Recession Probability Indicator (RPI) is currently estimating that it’s highly unlikely the economy is shrinking or will soon slip over the edge. That doesn’t mean macro risks are absent – quite the opposite. Rather, RPI reports that the quantitative signals that usually flag elevated recession risk are subdued at the moment. (RPI aggregates and processes data from three business‑cycle indicators published by regional Fed banks — see here for details.)

Last week’s release of payrolls data for May aligns with RPI’s growth bias. Hiring increased by 172,000 positions last month, beating expectations by a wide margin and marking the third straight month of relatively strong employment gains. Meanwhile, the jobless rate was unchanged at a low 4.3%.

While hiring has remained relatively resilient, the majority of recent job creation has been concentrated in the healthcare and hospitality sectors, and many other industries continue to struggle. At the same time, consumer sentiment remained near record lows in May, signaling a considerable degree of unease among households.

From a top-down perspective, however, the near-term outlook remains upbeat. For example, the Atlanta Fed’s GDP nowcast for the upcoming second‑quarter economic report is on track to accelerate to a 3.3% annualized pace, according to the bank’s model (June 9). If correct, the rate of output’s increase will more than double from Q1’s 1.6% advance.

None of this should dismiss the concern that the ongoing effects from the crisis pose a threat to the economy, primarily in the form of higher inflation. The key variable is how long the conflict lasts, which will likely determine when energy exports through the Strait of Hormuz rebound to something approximating normal — a shift that would, in turn, likely cool the recent inflation surge.

Forecasting such a turn of events is extremely challenging, although that won’t stop journalists from posing the question to Kevin Warsh, the new Federal Reserve chair, who will field these and related topics for the first time at the central bank’s press conference next week.

The economy’s resilience to date will give the Fed cover for leaving interest rates steady at next week’s June 16–17 policy meeting. But the resilience also suggests a strengthening case for raising rates. If economic activity is firming at a time when inflation is heating up, tightening monetary policy is a reasonable response at some point.

Fed funds futures currently estimate low odds for a rate hike next week and at the subsequent meeting in late July. But sentiment is starting to lean into a hawkish policy pivot later in the year – an outlook that will continue to resonate if recession‑risk odds stay low.

• New research provides strong evidence that investor beliefs—not fundamentals—drive long‑term market dynamics

• Sophisticated investors tend to be contrarian, while retail investors often extrapolate past returns.

• Valuation ratios like CAPE reflect sophisticated—not retail—expectations about future returns

How do financial markets price stocks? The answer matters because it provides information for designing and managing investment strategies.

A dominant line of analysis in asset pricing argues that long-term stock market fluctuations are driven by fundamentals like time-varying risk premia. However, a new research paper challenges this understanding by modeling the market as an interaction between naive investors (whose beliefs are decoupled from fundamentals) and sophisticated investors, using a new 70-year dataset to support the findings.

A key takeaway is that shifts in valuation ratios are almost entirely driven by expected changes in investor sentiment and price mean-reversion, not by changing expectations of dividend or earnings growth.

The paper also provides more context and support for engaging in tactical tilts at times. The standard academic and industry view—rooted in the Efficient Market Hypothesis (EMH)—holds that markets are broadly “efficient,” making buy‑and‑hold, market‑cap‑weighted indexing the logical baseline. Volatility, in this framework, simply reflects “rational” investors updating expectations. The EMH has been hard to beat over long horizons, but behavioral finance has steadily shown that real‑world investing is more complicated. Markets may be efficient enough to justify indexing, yet not so efficient that tactical adjustments are entirely pointless.

A new research paper strengthens this case for periodically adjusting portfolios beyond what a simple buy-and-hold strategy implies. In Beliefs and Stock Market Fluctuations: New Evidence from the Past Seven Decades, MIT Sloan economists David Thesmar and Emil Verner analyze seven decades of data and uncover three central findings about how different investors form expectations.

Sophisticated Investors Are Contrarian; Retail Investors Extrapolate

The idea of a unified “market consensus” is misleading. Beliefs are fragmented—and often move in opposite directions. Retail investors, as shown in surveys, are highly procyclical and extrapolative: when markets rise, they assume gains will continue and their expected returns peak near market tops. Value Line analysts, who are used in the paper as a proxy for “sophisticated” investors, behave very differently. Their expectations are countercyclical: when markets fall, they anticipate higher future returns.

Valuation Ratios Reflect Sophisticated, Not Retail, Expectations

Valuation metrics, such as the cyclically adjusted earnings-price ratio (CAPE) and earnings-price (E/P) ratio, have long been known to predict long‑term returns. Thesmar and Verner show whose beliefs they actually capture. A time‑series regression of the market’s earnings-price (E/P) ratio on Value Line’s expected returns produces an R² of 65%. Low valuations tend to align with high expected returns among sophisticated investors—exactly what rational models predict. Retail surveys generally show no such relationship. A Campbell‑Shiller decomposition reinforces the point, the study notes:

• Roughly 60% of variation in price-earnings ratios stems from shifts in sophisticated investors’ expected returns.

• 0% comes from expected changes in cash flows or dividend growth.

A graphic in the study captures the point, showing that the Value Line expected returns “account for a large share of movements in valuation.”

Disagreement Drives Volume and Volatility

If sophisticated investors are closer to rational, why do bubbles and crashes still occur? Limits to arbitrage. When retail optimism surges, naive investors buy aggressively, pushing prices above fundamentals. Sophisticated investors recognize the mispricing but cannot fully counteract it due to risk constraints. The resulting expectation gap fuels trading. When disagreement between Value Line and retail investors spikes, market volume and volatility jump as the two groups trade against each other.

The authors report that retail investors at times persist in pushing prices away from fundamentals, while sophisticated investors trade against them and can forecast future returns. The historical record, in other words, supports contrarian‑leaning strategies at times. In the jargon of financial researchers, “heterogeneous beliefs matter for market dynamics,” the paper notes.

Theory and Practice

This is old news for some investors. The likes of Warren Buffett and other value investors have been profitably exploiting this behavioral gap for decades. By some accounts the Oracle of Omaha’s impressive track record is an anomaly. Thesmar and Verner’s research, however, suggests there’s a recurring behavioral risk factor embedded in the stock market that can be used for tactical tilts, even within an indexing‑first philosophy.

Markets are smart, but they aren’t flawless. While low-cost indexing remains the smartest anchor for most portfolios, this research reminds us that human nature never changes. For the indexing-first investor, that means the occasional tactical tilt may not just be a gamble—recent research increasingly suggests it’s a data‑driven response to a persistent behavioral reality.

• Hotter inflation will feature at Warsh’s first policy meeting and press conference this month

• His June 17 debut will reveal how he handles rising price pressure

• The Treasury market hints at a rate hike in the near term

Federal Reserve Chair Kevin Warsh will preside over his first Federal Open Market Committee (FOMC) meeting later this month (June 16–17). Ahead of his public debut as the top central banker, monetary policy is essentially neutral for the first time in 2½ years, according to TMC Research’s estimate. Inflation, by contrast, is trending higher, which may set up an early challenge for the newly minted Fed chief.

Fed funds futures are still pricing in a near‑certainty that the Fed will leave its current 3.50%–3.75% target range unchanged this month, but the Treasury market is sending a different message for later in the year. The 2‑year Treasury yield — widely viewed as a proxy for policy expectations — is trading just above 4.0%, moderately above the high end of the Fed funds target range and implying that a rate hike may be near.

The concern is that the recent pickup in headline inflation will soon force the Fed’s hand and trigger one or more rate hikes to offset renewed pricing pressure. The case for rate hikes has been debatable, even after the inflation jump triggered by the conflict in the Middle East. TMC Research’s Fed Funds Model has estimated policy as moderately tight, offering a degree of inflation‑fighting medicine. But that mildly hawkish bias has continued to fade in recent months and is now essentially neutral, leaving the Fed vulnerable if inflation holds at current levels or rises further.

Several measures of inflation have jumped in recent months, driven by the Middle East supply shock that has lifted energy prices. The year‑over‑year change in the Consumer Price Index (CPI) rose to 3.8% through April — a three‑year high and substantially above the 2.4% pre‑war pace in February. Core CPI, which strips out food and energy and is a more reliable measure of underlying inflation, is also edging up but remains considerably softer at 2.7%. In both cases, inflation is running hotter than the Fed’s 2% target.

Warsh’s preferred measure of inflation, by contrast, suggests that inflation is lower and stable, giving the Fed chair more leeway to argue that rate hikes are premature. In his Senate confirmation hearing in April, he said he favors “trimmed” inflation measures, explaining that they offer better signals of underlying trends.

The Dallas Fed’s Trimmed Mean Personal Consumption Expenditures (PCE) Index, for example, rose 2.4% for the year through April, unchanged from March and only slightly higher than February’s pace.

Critics push back by noting that the trimmed‑mean PCE Index was slow to react to the 2021–2022 inflation spike, and so relying on this alternative measure could set the Fed up for another delayed reaction that gives pricing pressure room to run.

The Cleveland Fed’s inflation nowcast, however, suggests the current inflation run may be peaking. Headline CPI is expected to ease modestly in June to a 3.9% year‑over‑year rate, down from a projected 4.2% increase in the upcoming May report. Core CPI, meanwhile, is on track to hold steady at 2.8%.

The question is how the 12 members of the FOMC interpret the data. The focus on June 17 will be on the first among equals for policy votes — Warsh — who gives his first press conference as Fed chair that afternoon.

His preference for trimmed‑mean inflation will be under scrutiny, and will likely be subject to questions from the press. How he defends that preference under the glare of a live press conference will offer the first real clue about the kind of Fed chair he intends to be.