U.S. economic outlook

Key themes

• The U.S. economy remains resilient but is unlikely to accelerate in the second half of the year. AI-related capex shows few signs of slowing, but its direct boost to growth continues to be partially offset by the surge in tech imports. The AI buildout has been indirectly supporting consumer spending through stronger household balance sheets, but consumption growth is unlikely to pick up meaningfully in the near term as support from tax refunds fade, real income growth remains soft, and the saving rate sits at a multi-year low. We look for real U.S. GDP to advance at a 2.1% annualized rate in the second half of 2026, broadly in line with the 2.2% year-over-year rate we estimate was registered through Q2.
• The labor market is stable, not heating up. The June employment report revealed a cooler pace of job growth, with the three-month average pace of payrolls downshifting to 111K from 188K previously. And while the unemployment rate edged down last month, it stemmed from more workers leaving the labor force. We look for the jobs market to remain roughly in balance through the second half of the year, with unemployment hovering near its current rate of 4.2%.
• Inflation remains the rub, although June data buys the Fed more time to assess the outlook. At 3.4%, the year-over-year rate of core PCE is at a two-and-a-half-year high. The pickup primarily reflects tariffs, the knock-on effects of higher oil prices, and surging demand for tech-related goods—the latter of which Fed officials seem to have a harder time looking through. But, the upturn in inflation showed hints of leveling off in June. The latest CPI and PPI data point to core PCE rising just 0.2% in June, which would be the smallest monthly gain this year and would push the 12-month change down to 3.3%.
• The Fed has turned more hawkish. While we do not believe monetary policy is well-equipped to rein in the factors currently driving inflation higher, patience for returning inflation to 2% is clearly wearing thin at the Fed. Chair Warsh has been careful not to signal where he thinks policy is headed in the coming months. Yet, June’s evenly-divided dot plot, the latest meeting minutes, and recent comments from Committee bellwethers John Williams and Chris Waller suggest the bar for hiking rates is lower than it was a few months ago.
• Our base case remains for the FOMC to stay on hold this year, but the potential for hikes is high. With the tariff shock fading and services inflation continuing to slow, we expect inflation to make some directional, if modest, progress in the second half of the year. We estimate core PCE will edge down to 3.2% on a Q4/Q4 basis, which would be consistent with prices rising a little less than a 3% annualized rate in the second half of the year. That said, renewed hostilities in the Middle East, unrelenting demand for all things AI, and an increasingly impatient FOMC create the risk that the Committee engages in a modest tightening cycle in the months ahead. With the FOMC already on the fence between holding and hiking, even a small upward adjustment to the inflation outlook would likely lead the FOMC to reverse some of last year’s cuts.

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