U.S. economic outlook

Key themes

• GDP Remains on an Upward Trajectory: The 2.0% quarterly annualized pace of real GDP in Q1 showed a generally sturdy pace of expansion ahead of the Iran war. The quarterly rise largely reflected resilient (though moderating) consumer spending and strong AI-related investment. Despite recent volatility and renewed geopolitical and trade uncertainty, the initial read on incoming data for Q2 suggests growth has not materially deviated off this path.
• AI Capex and Fiscal Shock Absorbers. Looking ahead, fiscal stimulus should help negate the impact of higher oil prices on the household sector, allowing for a steady pace of consumer spending this year. Meantime, AI-related business investment appears to be accelerating, which should provide an offset to tepid investment in interest rate sensitive sectors such as nonresidential and residential construction.
• Inflation Pressure Lies Ahead. We have slightly pushed up our forecasts for both headline and core PCE inflation. In terms of the headline, higher oil prices are exerting upward pressure on energy prices, with knock-on effects on food inflation likely in train. Meanwhile, core inflation is likely to experience cost-push pressure related to the AI buildout. A moderating trend in shelter costs and fading tariff impacts seem likely to provide a disinflationary counterweight. Still, we now expect core PCE inflation to peak at 3.5% in Q2 and end the year at 3.1%, modestly higher than our March forecast.
• Labor Market Stable Within No Hire/No Fire Context. The recent string of monthly job gains and continued low readings on initial jobless claims indicates that the labor market is not spiraling downward. Beneath the surface, however, conditions are far from ideal. Low hiring rates and moderating wage growth continue to signal sluggish demand for new workers. In our view, there are not many catalysts for a meaningful pickup in labor demand on the near-term horizon, with delayed monetary easing, heightened geopolitical uncertainty, and firms increasingly allocating capital toward AI. Thus, we continue to anticipate a modest pace of hiring in coming quarters and see nonfarm payrolls averaging 55K per month over the balance of the year. The moderate pace of job gains should coincide with the unemployment rate drifting up to 4.4% in Q3, where it is likely to hold through year‑end.
• The Fed's Next Move Is a Cut. We are sticking with our call for additional monetary easing in 2026. Higher inflation in the wake of Iran war will continue to instill a "wait and see" approach, however, we still view the balance of risks as tilted toward underlying weakness in the labor market, despite recent signs of stabilization. As such, we continue to foresee 50 bps of reductions this year. We remain agnostic on the timing, however, are penciling in 25 bp cuts at both the October and December FOMC meetings, somewhat later than our previous forecast.

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