What the Fed Should Do

We find the risk of a major drawdown low, and aren't changing our sector or asset allocation weights but rebalancing is prudent risk management

In this week’s note:

• Market Sentiment and “Overbought” Conditions: Despite a relentless, AI-heavy rally, current capital expenditure (capex) and credit market data do not yet show the “bubble” signals seen in 2000 or 2014; however, we suggest trimming tech positions as a prudent risk management step against increasing benchmark concentration.

• Near-Term Correction Risks: While the probability of a major pullback is considered low, potential triggers include a “monetary policy mistake” regarding energy prices, a growth scare following 2Q26 earnings, or “monetization shocks” if and when major AI players like OpenAI or Anthropic launch IPOs.

• Inflation and Monetary Policy Shift: We argue that pandemic-era inflation was a fiscal/monetary phenomenon (not just supply chains); and suggests the “Warsh Fed” should combat persistent inflation by reducing the maturity of its bond holdings (SOMA portfolio) rather than further hiking rates, which would hurt small businesses.

• Labor Market Dynamics: Despite “stable” headline unemployment (U3), the labor market is described as being in an “unstable equilibrium,” with a contracting labor force and a significant year-to-date drop in the household survey of over 1.3 million jobs.