Interest Rate Game and Asset Opportunities under Triple Constraints of U.S. Inflation, Employment, and Fiscal Policy

Huitong Network, Nov 2—— A Panorama of the Current US Economy

The US economy is currently caught between a set of conflicting signals: headwinds persist from Middle East-driven high oil prices leading to energy inflation and its spillover effects, fiscal deficits, and ongoing labor supply constraints, while corporate earnings are supported by AI capital expenditures, maintaining high growth. The Federal Reserve's rate hike decisions, along with policy shifts from the midterm elections, add a large amount of uncertainty to the equities markets and asset pricing.

This article draws on information collected recently in an attempt to paint an overall picture of the current US capital markets for readers.

Mixed Fundamentals: Persistent Challenges in Housing, Inflation, and Oil Prices

The internal signals of the US economy are mixed, with structural imbalances persisting.

Inflationary pressure has not been fully dispelled, and energy prices are a major disruptive factor. The market is hoping for an easing of tensions in the Middle East to lower oil prices and reduce inflation stickiness.

The housing market remains a chronic issue: strict zoning regulations and lengthy approval processes suppress new home supply, while a large population is concentrated in a handful of high-cost cities, continuously raising the barriers to homeownership.

Market perceptions are also changing. Many now believe that buying a home is not the only option; in an environment of high home prices, renting is sometimes a more rational financial decision.

There is also growing policy advocacy for raising the capital gains tax exemption on primary residences to reduce tax burdens for families exchanging homes.

Hidden Concerns in Employment: The Fed's Dilemma Is Coming to Light

Fed Chair Powell stated in recent press conferences that overall employment remains stable, with the unemployment rate staying at low levels and initial jobless claims at multi-decade lows.

However, beneath the strong surface, endogenous growth momentum is weakening.

This year, average monthly non-farm payroll growth has been only 68,000, with institutions predicting only 55,000 new jobs added in October and unemployment holding at 4.2%.

Shrinking labor supply is a core reason, as tighter immigration policies and an aging population compress the labor pool.

Although overall layoffs are not high, the re-employment difficulty for the unemployed is rising, and the proportion of long-term unemployment remains persistently high.

Industry divergence is clear: previously stable job absorbers like healthcare and social assistance sectors have notably cooled in hiring, while only construction, manufacturing, and data center-associated positions have seen slight recoveries.

This presents a thorny problem for the Fed: raising rates can suppress inflation, but heightened financing costs would further erode already weak job absorption capacity.

Policy must be finely tuned to both suppress inflation and avoid triggering a significant weakening in the job market.

US Treasury Yields Fluctuate Sharply, Rate Hike Expectations Remain Uncertain

Interest rate expectations are the main thread in all asset pricing.

The Fed maintained the federal funds rate between 3.75%-4.00% at the October meeting; however, inflation remains distant from the 2% target, with the futures market pricing in a roughly 75% probability of another 25bp hike in December.

The 10-year US Treasury yield briefly surged to 5.36% at the start of October, a 24-year high, before retreating below 5%. The rapid repricing of yields has impacted all market assets.

Most surveyed fund managers believe year-end rates will likely fall in the 4%-4.25% range, and over half of institutions find current rate levels broadly appropriate.

In fixed income allocation, after years of a bear market, capital is beginning to prefer shorter-duration products, mainly 3-year bonds, to balance duration risk and coupon income.

Midterm Elections May Rewrite Policy: Tariffs and Fiscal Issues in Flux

This institutional survey shows that 84% of respondents expect Democrats to win control of Congress, while two-thirds believe Republicans will hold the Senate. Ultimately, a split Congress is the most likely outcome.

A key focus in trade is that tariff legislative powers reside with Congress, and the President's tariff powers can be revoked. If Democrats achieve a "blue wave", it is possible Congress will repeal current tariffs.

Market assessment of current fiscal policies is generally low, with only 5% of institutions rating current government fiscal policy as an "A"; 60% graded it as "D" or "F". Unrestrained fiscal spending and tariff policies are seen by many investors as main drivers behind the rise in long-term US Treasury yields.

AI Trading Winds Shift: Computing Power Craze Fades, Return Realization Becomes Core Issue

The key driver of the current US equity bull market has been the AI capital expenditure cycle, but internal differences among institutions have widened significantly.

Bulls argue that it has only been four years since ChatGPT landed, and compared to the eight-year capital investment cycle of the internet in the 1990s, the AI upcycle is still in its early stages.

FactSet data shows that S&P 500 EPS is expected to surge 34.4% this year, with a further 16% growth forecast for 2027, supporting strong earnings momentum.

Bears continue to warn of the risks of overcrowding: funds are too concentrated in the AI sector, and Nvidia's credit-support model for customer chip purchases is being likened to the vendor financing loop seen during the internet bubble.

The survey data is highly instructive: only 37% of institutions believe that AI infrastructure investment will yield positive returns over the next 24 months, while 32% expect it to be unprofitable.

The market's appetite for exposure to the computing power segment has moderated, and there is no longer a mindless chase of computing expansion logic.

Many funds are choosing broad-based indices like VOO to diversify AI single-stock blowup risk and avoid concentrated bets on individual computing power stocks.

The proportion of bullish fund managers on US equities over the next 12 months has dropped to 50%, compared to 54% in the spring survey; bearish views have risen to 24%, with neutral at 26%.

In terms of valuation, the S&P 500’s expected PE for 2027 stands at 18.4x, slightly below the five-year average—with bulls arguing that as long as earnings do not collapse, valuations are not expensive; however, 40% of institutions still say the market is overvalued, and only 10% see it as undervalued.

By sectors, information technology and healthcare are the most favored, though the tech sector is also one some funds seek to avoid.

In global allocation, nearly half of institutions believe US stocks will outperform overseas markets over the next year, but 71% are bullish on non-US equities, with 38% planning to increase overseas allocations and European banks being most favored;

Emerging markets are viewed with general caution, as a strong US dollar and high US Treasury yields create an unfriendly environment.

Another noteworthy detail: this year, only 51% of professional investors outperformed the S&P 500, as tech-stock concentrations combined with dramatic macro volatility have made active management much more difficult.

Core Market Tracking Clues Going Forward

First, oil prices and inflation remain the most critical clues influencing interest rates, investment risk appetite, and valuations,

Next is the October non-farm payrolls data to be released on November 6, to test whether high rates continue to erode employment; with inflation, this jointly determines the neutral rate and the Fed's future direction. Particular attention should be paid to the 2-year Treasury yield as a leading indicator for rate decisions, while movements in long-end Treasury yields will continue to set valuation anchors for growth stocks.

Then comes the final midterm election results, which may be announced around 2 days later—or possibly delayed. The base case is that Trump will lose the House but hold the Senate, with a possible risk near December 11 of another government shutdown, since the currently effective continuing resolution (CR) signed on September 2 keeps federal funding in place until December 11, 2026.

Next, AI corporate capital expenditures and cash flow realization, along with intensive Q3 reports, will test whether AI investments can turn into real profits, determining whether the tech-stock concentration trade can continue;

Then, if AI selling pressure abates and liquidity stabilizes, gold prices can be tracked alongside oil prices, US inflation, and the labor market, to observe whether a turning point in gold emerges.