The S&P 500 fell last week, with technology leading the way lower, as the Middle East conflict flared back up, oil jumped, and Treasury yields pushed to new highs for the year. The 2-year Treasury yield reached 4.33% and the 10-year hit 4.68%, both the highest since early 2025.
But a handful of under-the-radar developments suggest the picture is a lot better than we keep hearing. Below, we walk through the good news under the surface, and then turn to the week’s main event: a Federal Reserve meeting carrying more uncertainty than any in recent memory.
A New High Nobody Noticed
Let’s start with the second-largest company in the market. It had been lagging the biggest names by a wide margin, and last week it quietly climbed to a fresh all-time high—and almost no one seemed to notice. There was a time a new high like that would get some attention. Now? Hardly anything. Call us contrarian, but we like seeing new highs met with a shrug. When the crowd stops cheering the obvious, there’s often more room to run. If some of the long-lagging megacap names are quietly finding their footing again, that’s a sign of broadening participation, which is exactly what you want to see in a healthy bull market.
More Businesses Are Being Created
Here’s one you won’t see leading the evening news: More Americans are starting businesses. Business applications rose again in June, up about 1% from the prior month, to one of the higher levels on record. The bears will say people are only doing this because the job market forced them into it. We disagree. Starting a business is the ultimate act of confidence—you don’t do it unless you believe in yourself and in where the economy is headed. We saw the same uptick back in 2022 and flagged it as a reason to doubt the “recession in 2023” crowd.
The K-Shaped Gap Is Narrowing
This next one is more controversial, but the data is the data. Plenty of people are still struggling, which is why the economy has looked K-shaped, split between those who own assets like stocks and real estate and those who don’t. Wages tell a different story. In June, higher-income after-tax wage growth eased to 4.2% year-over-year, while the lower-income group climbed to roughly the same level. Higher incomes have rolled over, while lower incomes are steadily grinding higher. Rising pay at the lower end tends to show up quickly in spending, since those households spend a larger share of every extra dollar. That’s a tailwind, and not something you’ll hear about on TV.
The ‘Shrinking’ Middle Class Is Actually Moving Up
Finally, the media loves to tell you the middle class is shrinking—and it is, but not for the reason they claim. Thanks to years of a strong bull market in stocks and real estate, households have been moving up the ladder, not down it. Back in 1979, nearly 30% of families were poor or near-poor; today it’s under 19%. The upper-middle class has gone from about 10% of families to more than 31%. Across the board, the long-term trend has been improvement.
Nothing here is perfect, and last week was a reminder that plenty can still go wrong. But step back from the daily ups and downs, and the under-the-surface picture is a lot healthier than the headlines let on.
A Coin-Flip Fed Meeting
The Federal Reserve’s next meeting is this week (July 28–29), and the level of uncertainty around what the committee may do is the highest we’ve seen in recent years, especially this close to a meeting. The probability of a rate increase is at 37% as priced by the futures market, which is close to coin-toss odds—maximum uncertainty. The committee is clearly divided on the inflation outlook, and Fed Chair Kevin Warsh has refused to say which way he’s leaning or how he may choose to make up his mind, and this uncertainty is being reflected in markets. Warsh has said he wants “messier meetings,” which is all well and good when you don’t have an inflation problem, but that’s not the case now.
The market thinks the Fed has an inflation problem and will eventually combat it with higher interest rates. US Treasury yields have risen along with oil prices, though oil prices only serve to crystallize the inflation problem. As we’ve been pointing out since the start of the year, the Fed’s inflation problem goes beyond energy and is more broad-based:
- Energy prices are rising again, and that will put pressure even on core inflation via airfares.
- Supply chain bottlenecks emanating from the Middle East, especially for things like fertilizers, are going to put upward pressure on food prices. Keep in mind that restaurant prices are included in core inflation.
- Tariffs continue to hit input prices for manufacturers, and as a recent study from Federal Reserve researchers found, these have yet to fully translate to consumer prices.
- AI-related bottlenecks are pushing prices higher for chips and all sorts of electronics equipment, including computers.
- Services ex-housing inflation is still running hot, telling you that wage growth is likely running hotter than the pre-pandemic pace, feeding into faster nominal spending growth.
The messy inflation outlook has resulted in higher short- and long-term yields:
- The 2-year Treasury yield hit 4.33%, 0.96 percentage points higher than the 3.37% level on the eve of the war (February 27) and the highest since early 2025.
- The 10-year Treasury yield hit 4.68%, 0.74 percentage points higher than on the eve of the war, and also the highest since January 2025.
The 2-year yield is essentially the market’s expectation for average short-term policy rates over the next two years. The current policy rate is 3.63%, so a 2-year yield of 4.33% is 70 basis points above that, implying the market expects the Fed to raise rates three times (0.25 percentage points each time) and keep them elevated.
But Wait, Rate Hikes Won’t Result in More Oil (or Chips)
This is a common line of thinking right now: How will rate hikes “solve” the inflation problem? It’s not like higher interest rates will result in more oil being produced, or even more semiconductor chips. If anything, higher interest rates may crimp supply even further as producers pull back.
However, a recent speech by Fed Governor Chris Waller tackled exactly this question. The overall speech was clearly hawkish, albeit conditional on data. Waller said he’s in favor of holding rates steady if core inflation begins cooling, but he would consider near-term hikes if it remains hot or accelerates. The good news is that the June Consumer Price Index (CPI) data came in quite soft the day after his speech; the bad news is that the softness was not broad-based. The Fed’s own preferred measure of inflation, the Personal Consumption Expenditures Price Index (PCE), is going to be hotter. The inflation problem hasn’t gone away.
Waller accepts the basic premise: Higher interest rates cannot create more oil, semiconductors, memory chips, or shipping capacity. Monetary policy cannot directly repair the supply side. But that does not make monetary policy irrelevant. The Fed may not control the initial supply shock, but it can influence whether that shock becomes persistent, economy-wide inflation. The key distinction is between the first-round effects of supply shocks (oil supply falls, so oil and gasoline prices rise), which higher rates can’t fix, and second-round effects, where they can have an impact. You get second-round effects of supply shocks when higher energy costs spread into transportation, manufactured goods, and services; businesses raise prices more broadly; consumers continue spending strongly enough to absorb those increases; wage and price behavior adjusts; and inflation stays elevated after the original oil shock fades. Rate hikes are aimed primarily at preventing those second-round effects.
Rates Can Bring Demand in Line With Reduced Supply
A negative supply shock means the economy can temporarily produce fewer goods and services at existing prices. If aggregate demand remains unchanged, too much spending is chasing reduced available supply. Higher rates restrain interest-sensitive spending, credit creation, investment, and asset price-supported consumption. They therefore bring demand into better alignment with constrained supply. The goal is not to manufacture more oil. It is to stop total nominal spending from continuing as though the supply loss never happened.
Consider a stadium that suddenly has 20% fewer seats. The Fed cannot build more seats, but it can reduce excess demand so that ticket prices do not keep cascading upward across the entire event economy. That adjustment can be painful, but the alternative can be sustained inflation.
The Fed Targets Overall Inflation, Not Oil’s Relative Price
A supply shock should raise the relative price of the scarce item—oil becomes more expensive compared with other goods. But that does not automatically require prices throughout the economy to keep rising. For inflation to remain elevated, other prices must also increase, or total nominal demand must accommodate the shock. Tighter policy allows the oil price to rise while creating downward pressure elsewhere. Consumers who spend more on gasoline have less to spend at restaurants, at retailers, or on other services, and higher rates reinforce that reallocation. In other words, the Fed cannot stop oil from becoming relatively more expensive, but it can resist an increase in the general rate of price inflation.
What’s Next?
The most important point Waller made is that he’s not considering rate hikes simply because oil prices increased. Inflation is more broad-based, and Waller acknowledges that. His concern is that underlying demand and broader pricing dynamics may already be too strong, independent of the direct energy effect.
The good news is that inflation expectations, as implied by markets, are consistent with the Fed’s 2% target—but that’s because investors expect the Fed to raise rates and keep them elevated. If the Fed tolerates high inflation and expectations become unanchored, it may later need much larger, faster, and more persistent rate hikes, increasing recession risk.
The Fed cannot reverse a supply shock, but it controls the nominal-demand environment in which the shock occurs, as it did with Russia’s invasion of Ukraine on top of persistent COVID-related supply disruptions. If demand remains resilient, inflation is broadening, and employment is already near maximum, keeping policy too loose could validate and propagate price increases. Nominal consumer spending has clocked in at an annualized pace of almost 7% over the last two months for which we have data (April–May), and 6.3% over the prior 12 months. That’s hot. Inflation-adjusted “real” growth is OK, but well below the 2023–24 pace, and even the 2018–19 trend of 2.2%.
Waller also recognizes the risks. The labor market is not as overheated as it was in 2022, so additional tightening is more likely to raise unemployment rather than merely reduce vacancies. Ultimately, the next several core inflation readings will matter a lot, never mind Warsh’s preference for not giving “forward guidance.” The Fed is going to have to differentiate between a temporary relative-price shock that should be looked through and a generalized inflation process that requires demand restraint. They were late to the game on this not so long ago. The question is, how much are they willing to risk letting it happen again? The market’s answer to this right now seems to be “we don’t know,” but the market does seem to have some conviction that the longer the wait to find out, the more likely inflation becomes a persistent problem that will be more costly to reverse.
S&P 500 — A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly traded companies from most sectors in the global economy, the major exception being financial services.
The views stated in this letter are not necessarily the opinion of Cetera Wealth Services LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. This information is from sources believed to be reliable, but Cetera Wealth Services, LLC cannot guarantee or represent that it is accurate or complete.
9043401.1-0726-C
