Fed policy and market dynamics: Insights from Denise Chisholm - September 11, 2025
Fidelity’s Director of Quantitative Market Strategy Denise Chisholm, shared her insights on inflation trends, Federal Reserve policy and sector-specific dynamics.
Here are some of the key points from her commentary.
Inflation trends and Federal Reserve outlook
Denise highlighted that while July’s U.S. Consumer Price Index (CPI) showed slightly higher growth than expected, the Federal Reserve focuses on the Personal Consumption Expenditures (PCE) deflator, which tends to register lower inflation. Analysts estimate a modest 0.2% rise in the PCE deflator. This distinction allows the Fed to continue normalising policy without aggressive rate hikes, as broad-based inflation from tariffs has been delayed. The increased probability of a Fed rate cut reflects slow but positive economic growth rather than a recession, creating a cautiously optimistic environment for risk assets.
Homebuilders: Interest rate sensitivity and valuation dynamics
Homebuilders, traditionally very cyclical and interest rate sensitive, have experienced contraction in residential investment during 2022-2023 despite the broader economy avoiding recession. Denise explained that the usual transmission mechanism, Fed rate cuts lowering mortgage rates to boost home sales, was ineffective last year due to inflation above 3.5% on a core basis. However, if inflation remains elevated but stable, a Fed rate cut could marginally improve housing affordability and revive demand. Homebuilders have significantly improved profitability since the late 2000s, with operating margins at historic highs. Although absolute valuation levels remain consistent with historical norms, relative valuations have been depressed due to interest rate sensitivity. This creates a potential risk-reward scenario: if home sales rebound, homebuilder stocks may see an increase, but market conditions can also impact the performance of these stocks.
Mortgage market dynamics and policy implications
Mortgage spreads, the difference between mortgage rates and Treasury yields, have widened to record levels due to the Fed’s quantitative tightening (QT), which includes selling mortgage-backed securities. This widening delays the positive impact of Fed rate cuts on mortgage rates, meaning borrowing costs for homebuyers may not immediately decrease after a rate cut. Potential policy shifts, such as spinning off Fannie Mae and Freddie Mac and ending QT in January, could normalise mortgage spreads. This normalisation could potentially influence housing affordability and demand, which could contribute to a housing sector recovery.
Top sectors
- Technology: Denise ranks this as the top sector for risk-reward potential, supported by strong fundamentals and a favourable response to Federal Reserve policy. Technology is positioned as a sector to benefit from current economic trends.
- Consumer discretionary: This sector is marked as second in line, buoyed by prospects of improved housing affordability stimulating consumer spending. Denise's view that a Fed rate cut could positively impact this sector, particularly homebuilders, which have a compelling risk-reward scenario.
- Financials: Ranked third, this sector benefits from attractive valuations and growth opportunities, especially in brokers and capital markets. Denise suggests that financials may potentially benefit from market dynamics.
Bottom sectors
- Energy: Denise see challenges in this sector due to profit normalisation after a highly profitable 2022. Denise advises caution, as energy is not recommended for ownership despite attractive valuations.
- Utilities: Traditionally defensive, utilities are highlighted as presenting a negative risk-reward profile. Denise points out valuation concerns and recent performance issues.
- Consumer staples: Another defensive sector, consumer staples, presents a negative risk-reward outlook, given recent performance concerns and valuation challenges.
Data dependence and market forecasting challenges
Denise emphasised the Fed’s data-dependent approach complicates policy decisions and market forecasting. Economic data, such as non-farm payrolls, are often revised and lagging, reducing their predictive power. Recent market trends indicate a temporary soft patch, with stocks showing potential for a recovery. However, she suggested that investors should remain open to scenarios involving persistent job market contraction and its implications for economic and market trajectories.
Conclusion: Strategic flexibility in a complex market
The current market environment is shaped by a balance of inflation dynamics, Fed policy expectations, sector-specific valuation trends, and macroeconomic uncertainties. Recognising signals from inflation measures, housing market sensitivity, mortgage market conditions, and sector rankings is vital. Homebuilders offer an attractive opportunity given their valuation disconnect and sensitivity to potential Fed rate cuts. Technology, consumer discretionary, and financials stand out as sectors with favourable risk-reward profiles, while caution is warranted in energy and utilities. The Fed’s reliance on revised data underscores the importance of maintaining strategic flexibility and monitoring market signals closely.
