LARRY KUDLOW: Mr. Trump, please give us a transformational Fed

Two Fed governors, Stephen Miran and Chris Waller, dissented at the Open Market Committee advocating a 25bp cut as the author argues the US is in a productivity-led, disinflationary expansion: three-month annualized core PCE ≈ 2.3%, three-month core CPI 1.6%, headline CPI ~2.1%, and unit labor costs up just over 1% year-over-year. The piece highlights falling energy prices and a capex boom from full cost expensing as counter-inflationary forces, questions why US bond yields remain elevated relative to Japan/China, and calls for a transformational, growth-friendly Fed and maintenance of a strong-dollar policy.

Analysis

Market structure: A productivity-led, capex-driven disinflation (3‑month core PCE ~2.3%, 3‑month core CPI 1.6%, unit labor costs ~1% YoY) favors long-duration growth, semiconductors, industrial equipment and REITs while penalizing rate‑sensitive financials and cash. If the Fed pivots to cuts (dissenters advocated -25bps) bonds would rally (10y yield down 50–100bps over 3–12 months possible), equities with long-duration cash flows (QQQ, VNQ) rerate higher, and implied vol (VIX) compresses. A persistently strong dollar (policy confirmed) keeps pressure on EM and commodities; falling energy prices are an additional deflationary tailwind for margins and real incomes.

Risk assessment: Tail risks include a reacceleration of wage inflation or an energy/geopolitical shock that spikes CPI >3% in 3 months, forcing a hawkish Fed and 10y >4% (large negative repricing for long-duration). Short-term (days–weeks) market moves will be driven by Fed guidance and jobs/PCE prints; medium (3–6 months) by corporate capex data and unit labor cost trends; long-term (12+ months) by structural productivity and tax/capex policy changes. Hidden dependencies: capex boom is tax‑sensitive (full expensing permanence); currency interventions or strong‑dollar doctrine could blunt export growth and EM debt stress.

Trade implications: Favor sector tilt into semis (SMH), industrials (XLI), and long-duration bonds (TLT) while underweight banks/financials (XLF/KRE) and cash. Use pair trades to express rate‑compression risk (long SMH, short XLF) and use defined‑risk options to buy optionality on a dovish pivot (6-month TLT call spreads, 3‑month QQQ call spreads). Time entries around clear catalysts: next 2 Fed communications, monthly PCE releases, and 1H 2026 capex data — initiate within 2–6 weeks and scale over 3 months.

Contrarian angles: Consensus assumes good growth => Fed tightening; the miss is that productivity and falling energy can decouple growth from inflation, making long-duration and capex beneficiaries underowned. Risk of overpricing long-duration assets exists if inflation unexpectedly reaccelerates; historical parallel: late 1990s productivity shocks that compressed inflation but later required policy normalization. Unintended consequence: an aggressive dovish pivot could compress bank NII and spark regional bank stress, amplifying dispersion and creating idiosyncratic long/short alpha opportunities.

Key Decisions for Investors

• Establish a 2–3% portfolio long in TLT (long-duration Treasuries) with a 6–12 month horizon; set a profit target of +10–15% and a hard stop at -6% if 10y yield rises >75bps from entry within 90 days.
• Establish a 3% long position in SMH (semiconductor ETF) paired with a 3% short position in XLF (financials ETF) to express capex/productivity upside vs. rate-squeeze risk; scale in over 2–6 weeks and re-weight if SMH outperforms XLF by >15%.
• Deploy 0.5–1% notional in a 6‑month TLT call spread (buy near‑ATM, sell +8–12% OTM) to capture a dovish pivot with defined risk, and alternatively a 0.5% 3‑month QQQ 5/12% call spread to play growth re‑rating ahead of next PCE prints.
• Trim bank exposure (specific: reduce JPM, BAC, C or XLF holdings by ~20%) within 30 days; redeploy proceeds 60/40 into SMH and VNQ. Re-assess if 3‑month core PCE exceeds 3.0% or the 10y Treasury moves >+75bps in 90 days — in that case cut long-duration positions by 50%.