The Monologue
Welcome to arc_Trajectories, our weekly note delivering updated guidance, commentary and research on the direction of travel of the economy and markets.
Inspired by the traditions of late-night TV, I'll start each note with a short monologue summarizing my personal take on the state of the private markets investing world. In the spirit of arcMacro's approach to the uncertain and unknowable future, I will not prognosticate. I will offer my opinions while committing to the discipline of giving the counter-arguments a fair hearing and changing my mind when the facts change.
Success would be asking the right questions and framing them simply and usefully, so that we have a good starting point for untangling what's really driving the economy.
Since this is our first weekly report, today's monologue serves as an introduction to the ongoing conversation we're aiming to develop with you, our clients.
Each note will come in two main parts. In the first, we'll look at what we've learned from the fresh data and news this week, and assess whether it shifts the outlook. We'll concentrate on highlighting just the key signals we've deciphered amid the general noise.
This week, we tee up a theme that we'll likely spend a lot of time on in the coming weeks and months: The U.S. economy is approaching a crossroads after a long period of so-so economic performance. Things must inevitably get decisively better or worse. The broad macro environment remains volatile, and the cross-currents are confusing, but we think we can see an emerging direction of travel that is more down than up.
We also highlight the astonishing continued performance of Gold this year (up +46% YTD), briefly point out why it's not your granddaddy's rally, and offer a few thoughts on how long-horizon illiquid portfolios might position for a sustained high price.
Part Two of the weekly note is where we deliver short, high-impact analysis pieces. Topics and length will vary, but the general theme will always come back to how our assessment of the macro translates to micro-level strategy and investing for our clients.
Following on from the commentary section, this week we bring you two deep dives related to the Fed. We're not at all convinced that rates can (should?) go much lower given the unpredictable drivers of the labor market and clear upside inflation risks. But as we point out in our second deep dive, financial conditions are already easy enough to support a gradual improvement in M&A activity, so it's best not to over-index on the Fed.
One last thing: at the bottom of any research article on our platform, you'll find a link that enables you to send us your questions and comments. Please make liberal use of it! Or you can email us at [email protected].
I look forward to building our weekly conversation together.
Dylan Smith
(P.S. No AI slop here—we used em dashes before it was cool. Every note and research report at arcMacro is hand-crafted. The robots help us wade through code and data more efficiently, but we draw the inferences ourselves. All opinions and errors are our own.)
Weekly Macro/Market Review
Macro Moves
The key U.S. data and events this past week:
- Powell Speech: Fed Chairman Jay Powell was more balanced on the labor market and inflation in his Monday speech, walking back some of the dovish expectations he created in the prior week's press conference.
- GDP Growth, Q2, 3rd estimate: +3.8% YoY annualized, revised up from +3.3% on the second estimate.
- Consumer Spending, August: +0.6% MoM (consensus: +0.5% MoM)
The mighty U.S. consumer and the mousy middle man
The sizable upward GDP revision and consumer spending beat are two chapters in the same story.
One thing you'll hear a lot from us at arcMacro is to try to avoid GDP. Lags and revisions aside, it was designed to be used as a welfare measure, not for tracking economic momentum. If you must look at the National Accounts, we prefer to use Gross Output (GO). GO measures all transactions along the economic value chain, both "B2B" (intermediate transactions) and "B2C" (final transactions), instead of netting out intermediate activity, as GDP does. GO vs. GDP is analogous to sales growth vs. profit margins when assessing a company.
The third release of the Q2 National Accounts data brought the GO estimate for the quarter. It's creeping to a standstill, at only 1.2% in Q2. Outside of final consumption, economic momentum is slowing as businesses pull back on costs, trim workforces, and look for cost efficiencies below the top line.
How is consumption so healthy when the rest of the economy feels frail? The simple answer is that it's better-off consumers who are doing the spending, and they're doing it instead of saving. The U.S. savings rate stands at 4.6%, Down from a 5.2% in May and below the pre-COVID-19 average.
The long equity bull market has left 401ks looking flush, giving consumers room to spend. That the broader economic outlook is now so tightly connected to the equity market should be cause for concern as valuations continue to break ground not seen since the Dotcom era.
This is what it's taking to keep the economy in what we define as a "Sluggish" macro regime, with below-trend and declining real activity and rising price pressures (see in the summary of our proprietary macro Factor and Regime framework below).
If you aren’t familiar with the framework, we encourage you to read our White Paper, the Might of Macro, which details our approach to macro tracking.
When you tally up the effects of what's "in the mail" for the U.S. economy – tariff pass-through, frothy stock markets, ongoing but potentially overstretched or peaking AI investment, ongoing but potentially stretched consumers, weak small business sentiment, very little fiscal room for manoeuvre, and a Fed than needs to keep more than an eye on inflation risk – it does seem that the more likely direction that the economy will break is downward.
But we're not there yet, and there is no way to assess the timing involved. A few policy course corrections could put the economy on sound footing, but we assess the likelihood of those corrections as being low.
Market Moves
It was a comparatively flat week for public equities, as Chairman Powell's comments on Monday cooled some of the optimism about a dovish path for interest rates. The S&P 500 stood pat, while the Russel 2000 small-cap index gave up -0.6%. The DXY dollar index strengthened somewhat, but remains nearly -10% weaker than where it started the year (a factor that is amplifying inflation risk). Spreads, for the most part, continued their narrowing trend.
In the private world, we're now seeing enough data, at least on deal counts, to see that September is shaping up to be a strong month, and Q3 is looking like one of the best third quarters on record. Improving exit volumes in both M&A and secondary buyouts is welcome news for GPs and LPs alike. Indeed, we're on track for almost a 3x improvement in aggregate exit volume in the U.S. in 2025 compared to 2024. The improvement in the deal flow is mostly down to larger deals getting over the line this year, rather than a bulk transactions improvement—mirroring a bifurcation we're seeing in all areas of the economy and financial system.
Should PE/VC go for gold?
Gold's latest spurt amid a spectacular two-year rally is worth touching on. The yellow metal is now up +46% this year, outperforming stocks, even the Information Technology (+20.7%) and Communication Services (+24.3%) sectors that contain the majority of AI stocks.
It's important to understand that this is a secular revaluation of the relative value of the asset. It's fueled not by traditional Western hedging appetites, but by permanently higher demand for gold as a reserve asset and store of value globally. Central banks (notably those of Russia, China, South Asia, and the Near East) are substituting USD reserves for gold. Retail investors from Turkey to India are doing the same. A rampant gold trading industry in China, where property speculators have transformed into goldbugs, is supercharging the price growth. And, having missed out on the initial action, Western consumers are now moving back into Gold ETFs.
The salient question is whether the illiquid assets industry should be looking for exposure. If you believe that gold's rally is structural, that it is a good source of diversification and the answer is yes. How then to implement that view?
This rally is built on demand for physical bullion as well as derivative exposure, so companies supporting the gold value chain are appealing. That might include mines, but we think security, storage and fractional ownership are more promising avenues. Additionally, fintechs offering retail exposure to gold (whether in the form of synthetic blockchain structures or more traditional mechanisms) has strong growth upside from a market growth perspective. Commodities are typically an unloved corner of the private equity market, but we think there is a good opportunity to diversify portfolio risk by looking at B2B services with an underlying gold exposure.
What we're watching next week
- Government shutdown risk: This issue will dominate the news cycle, but unless you're directly affected, you can mostly ignore it, at least from a professional standpoint. Research on shutdowns over the years has consistently found that temporary losses are made up for once the government reopens (unless you're based in central D.C.). The real damage is to long-term U.S. credibility, as reflected in credit rating and T-note spreads.
- Manufacturing PMI (Wednesday) and Services PMI (Thursday), two of the first data points on economic activity in September.
- Nonfarm payrolls (Friday). The consensus expectation is for an improvement in August (+50k from July's woeful +22k), but the smart money is watching utilization and labor force growth for signals on future labor market tightness.
Research Snippets
A naysay on Jay's rate play
After we learned that nonfarm payrolls grew by only +22k in July, the 25 basis point cut that the Fed locked in at its September meeting was inevitable. But Chairman Powell has shown far less concern about above-target and rising inflation than would be expected, even after his more balanced speech on Monday.
Let's go through the dynamics at play in the Fed's dual mandate.
Full employment
Powell was at pains to point out that slowing labor force growth (owing both to slowed population growth and lower workforce participation) is a big driver of slowing job growth. And he's right. Demand for workers is softening (now back to pre-COVID norms, so not exactly weak). But so is the supply of workers, as the Trump administration tightens immigration policy. The net effect on the unemployment rate depends on the relative scale of these effects, so the outlook for the unemployment rate, under this logic, is unknowable. We could see tight labor market conditions (firm wage growth) even as the economy weakens.
Inflation (2% target)
The subtext of Powell's speeches and actions recently has been almost tantamount to ignoring the 2% target. The Chairman has dropped all language focused on getting it there and shifted to a focus on the balance of risks within the labor market.
More importantly, he's relatively quiet on the upside risks. As the chart below shows, inflation has been running above target with import prices basically flat over the past two years. But now higher import prices (from both tariffs and the weaker dollar) will contribute to higher inflation, before we factor in the cost of substituting to more expensive domestic supply. We believe that core inflation creeping above 3.5% and toward 4% later this year will re-center prices in the debate and prevent a full-blown easing cycle.
In a nutshell, here is how we see the outlook on the Fed's dual mandate: Employment growth is slowing, but in a way that might keep the labor market tight. Meanwhile, the disinflation process has stalled and there are clear upside risks from tariffs and the weaker dollar.
Indeed, it's possible that a mild "stagflation" – rising inflation, falling real activity but with a tight labor market – is on the way.
That implies that the optimal policy is probably a "wait and see" approach with a bias to sitting on the tighter end of neutral to control inflation (at least for a heterodox independent central bank). And yet, as the "dot plot" on rate expectations from the September meeting shows, the FOMC is absolutely all over the map on where rates should be in both the short- and long-term. One member even expects two hikes this year! FOMC members have very different reads on the economy and the policy and politics driving it.
The Fed outlook has never been more muddy, in our view.
Will the Fed's cut spark off a latent surge of M&A activity?
In short, no.
But you wouldn't have been able to tell that from the media and professional commentary over the past couple of weeks. According to the industry, this 25bp was all we've been waiting for to turn on the deal making spigots.
That's not to say we don't think stronger M&A momentum is building, even in a soft economy. It clearly is. It just has nothing to do with the Fed.
Our Financial Factor, which measures broad financial conditions, is more than one standard deviation looser than the historical average, despite the Fed viewing its stance as "moderately tight."
And leveraged loan spread on everything except CCC continue to grind tighter.
The improvement in deal making has more to do with a generally healthy financial environment characterized by relatively low leverage and strong risk appetite, alongside market technicals, than it has to do with the Fed and monetary policy.
That's a positive, because it means the pickup has decent chance of proving durable even if the macro outlook is cloudy.