What a ‘Goldilocks’ economy means for your investments

After markets climbed the wall of worry in Q2, the third quarter of the year brought a mix of challenges and opportunities for global markets. Q3 was shaped by shifting monetary policies, technological advancements, and a balancing act in the U.S. economy. While uncertainty remains, there are reasons for optimism as we look ahead.

What’s shaping the markets?

Three key themes influenced markets this quarter:

1. The Federal Reserve’s (The Fed) interest rate cuts: signalling a shift towards easing financial conditions.
2. The U.S. economy: displaying ‘Goldilocks’ characteristics (not too hot, not too cold), but it was steady enough to inspire confidence.
3. The continued rise of artificial intelligence (AI): driving innovation, reshaping industries, and resulting in robust demand for its infrastructure. Importantly, many of the quality companies leading this trend have strong balance sheets, a competitive edge, and a track record of innovation through economic cycles – making them less vulnerable to broader macroeconomic headwinds.

These factors, alongside strong corporate earnings, have helped global stocks reach new highs. But what does this mean for your investments? Let’s explore the bigger picture.

Central banks take different paths

The third quarter saw major central banks begin to chart different courses.

In the U.S., the Fed cut interest rates by 0.25% in September, paving the way for further reductions in 2025 and beyond. The Fed has prioritised supporting the jobs market, even as inflation remains above target.

In contrast, the Bank of England (BoE) and the European Central Bank (ECB) have kept rates steady. The BoE is concerned by persistent inflation, while the ECB thinks inflation and interest rates are currently at a stable level.

What does this mean for your portfolio?

This divergence in central bank policies has important investment implications:

• Currency movements: the U.S. dollar is widely expected to weaken against sterling and the euro as the Fed eases interest rates, while the BoE and ECB hold firm.
• Gold prices: these have risen to a record high, driven by expectations of a weaker dollar, Fed rate cuts, and growing concerns about fiscal sustainability.

A closer look at the Fed drama

Q3 brought political drama that tested markets’ confidence in the Fed’s independence. Events included:

• President Trump’s vocal pressure on the Fed chair to cut rates.
• The president’s attempt to fire Fed governor Lisa Cook.
• The appointment of Stephen Miran, a Trump loyalist, as a Fed governor.

At September’s Fed policy meeting, it emerged that Miran voted for a more aggressive interest rate cut than the other Fed chair candidates – aligning with President Trump’s preferences. However, the broader voting patterns indicated that the Fed chair candidates were acting independently, free from political influence. This cautious approach has helped preserve investor confidence in the Fed’s credibility. Any compromise to this credibility could negatively impact both U.S. treasuries and the dollar.

Goldilocks in, bears out

The U.S. economy continues to tread a delicate path. True, there are signs of weakening, but it’s far from entering a downturn. This fine balance has revived the ‘Goldilocks’ debate: can the U.S. sustain steady growth with stable inflation, even in an era of tariffs?

Let’s explore the evidence.

A softer jobs market, but no recession in sight

The U.S. jobs market has undoubtedly softened in recent months:

• Job gains slowed.
• Vacancies fell.
• Wage pressures eased.

The slowdown in hiring could be part of a natural rebalancing after the post-Covid hiring surge, when job openings far exceeded the number of unemployed. It may also reflect temporary caution from companies amid lingering tariff uncertainty.

While a weaker job market increases economic risks, it’s not sinister enough to trigger a recession. Encouragingly:

• Household spending and retail sales remain resilient, showing that consumers are still confident.
• Wages continue to outpace inflation − historically an important condition for spending growth.
• Business optimism is improving, with forward-looking indicators like the Purchasing Manager Index (PMI) showing faster growth in order books.

These factors suggest the economy is far from “falling off a cliff.”

Overall, the U.S. economy remains on solid footing, despite some weak patches of data. This ‘temperate’ economy is what economists call a ‘Goldilocks’ economy − not too hot to force the Fed to keep rates high, but not too cold to risk an economic contraction.

This balance is positive for markets because:

• Easing financial conditions: the Fed believes current interest rates (4.25%) remain restrictive, but with the neutral rate estimated at 3%, that implies there’s plenty of room for future cuts.
• Real wage growth and tax cuts: these continue to support household spending and the case for a broadly resilient economy heading into 2026.

Historically, this type of environment – where rates are falling but a recession is absent – has been bullish for markets.

It all comes down to corporate profits

Corporate earnings have been stronger than expected despite tariff chaos in Q2. Technology continues to lead the way, with AI-related investments and infrastructure spending translating into real revenue and profit growth. Companies exposed to cloud services, semiconductors and enterprise software are reaping the rewards.

There have also been notable developments in the AI ecosystem:

• Mega deals and order pipelines: Oracle’s new cloud contracts and Nvidia’s investment in Intel have drawn attention to future demand and investor sentiment. And in a landmark move, Nvidia announced plans to invest up to $100 billion in OpenAI and supply it with data centre chips. This partnership brings together two of the most prominent players in the global race in AI innovation.
• Broader market participation: while the largest technology companies dominate performance, the stock rally is spreading. Small and mid-cap U.S. companies have also reached record highs, reflecting optimism about Fed rate cuts and continued inflows into U.S. equities.

The AI arms race: Risks and opportunities

The AI boom isn’t just about technology – it’s also geopolitical. The U.S. and China remain locked in competition over innovation and hardware. While this rivalry can create risks that unnerve investors, such as export controls or sales bans, it also presents opportunities.

Both countries are expected to continue investing heavily in AI infrastructure, supporting companies that drive innovation and technological breakthroughs. This dynamic has contributed to renewed optimism in the Chinese tech market, particularly after the ‘DeepSeek’ moment.

This backdrop benefits select Asian markets:

• China and South Korea: valuations remain attractive.
• Taiwan: continues to benefit from its strategic role in AI hardware supply chains.

These factors strengthen the case for being slightly overweight about Asia ex-Japan equities.

Portfolio implications

Given this environment, we are modestly overweight in equities in portfolios. The combination of Fed easing, steady growth, and strong corporate earnings likely provides support to risk assets. However, we’re mindful of the relatively high valuations in U.S. stocks, the bullish sentiment around AI, and the fact that rate cuts are already priced in – factors that are keeping us from taking on additional risks in portfolios.

In fixed income, we maintain a neutral stance but favour high-quality government bonds in select regions. Long-term yields are likely to remain elevated due to fiscal concerns and inflation uncertainty, but parts of the UK government bond curve offer attractive yields. The BoE’s hawkish stance may weigh on growth and dampen inflation, ultimately putting downward pressure on gilt yields.  

We also retain a modest overweight allocation to gold, which has reached record levels. Its appeal as a store of value independent of governments and monetary institutions remains strong. Global central banks – especially in emerging economies, are also diversifying their reserves from treasuries into gold, which is a secular tailwind for demand.

Looking ahead

The outlook remains balanced. Political, policy, and macroeconomic uncertainties are always part of the investing landscape. But markets don’t need perfection to perform well.

In a world full of noise, it’s important to focus on the bigger picture, like fundamentals and secular drivers. Innovation, resilient corporate earnings, and easing financial conditions continue to provide reasons for optimism.

As always, we’re here to help you navigate these opportunities and challenges, ensuring your portfolio remains aligned with your goals.

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