The Macro Backdrop

Remaining on the Moderate Growth Path

While the Memorandum of Understanding (MOU) in the Middle East war has resulted in a visible decline in energy prices, as of this writing, the uncertainty quotient on the U.S. macro backdrop from the prior run-up in oil and gasoline prices still hovers over the investment landscape. It is against this backdrop that we feel investors should try to ‘filter out the noise’ (not necessarily an easy task) and focus on the state of the underlying fundamentals of the economy.

For all intents and purposes, the economic backdrop coming out of Q2 remained not only resilient to outside shocks but also revealed a relatively solid performance. Arguably the most noteworthy difference in the outlook has come from the labor markets. Earlier this year, the markets were operating under the impression that new hiring was still lackluster, giving rise to the “no-hire, no-fire” mantra. However, since February the three-month moving average for total non-farm payrolls has gone from a slight negative reading of -4k to a rather healthy increase of +111,000. In addition, the unemployment rate has remained below 4.5% since November of last year.1

Needless to say, household spending is providing underlying support for the economy, even in the wake of higher energy prices. While a case could be made that higher “prices at the pump” may act as a ‘tax’ on the consumer, it is fair to ask whether the opposite should also be true: the recent drop in energy costs would remove such a tax at a minimum and possibly be viewed as a tax cut?

Another cylinder of the economic engine, fixed investment, is also providing a positive contribution to the overall economy. The massive build-out within the AI space is showing up in the categories one would expect as part of the Bureau of Economic Analysis’ GDP reports, and we anticipate this trend continuing. And don’t forget the positive impacts provided by the One Big Beautiful Bill on the federal government component.

On the other side of the equation, residential investment, net exports and inventories continue to be either wild cards or negative factors to contend with. In other words, not all five cylinders of the growth engine are firing away all at once. In addition, wage growth has recently fallen below the annual rate of inflation. While we don’t envision any notable retrenchment from the consumer, if continued, this could act as a cap of sorts.

Looking ahead, the aforementioned rebound in new hiring could potentially be pared back a bit in terms of upcoming monthly payroll figures. The last two years have seen either downward revisions or some cooling in the pace of new job creation during the summer months. Also, any increases due to the World Cup in areas such as leisure and hospitality could be reversed. A continued positive development is the fact that the key leading economic indicator, weekly jobless claims, continues to reside at levels that are about 100,000 below where they were historically prior to a looming recession onset.2

All in all, the underpinnings of the U.S. economy still seem to be on a relatively solid note and should help keep overall growth moderately positive during the second half of the year.

Inflation: Can the 2% Target Ever be Attained?

The Middle East war created an environment where any potential tariff-induced inflation fears were being outweighed by concerns of any pass-through from higher energy prices. Interestingly, some measures of inflation suggest that the peak tariff effects may not only be behind us but also be waning in terms of price pressures. Nevertheless, even without tariffs and higher energy prices, inflation remained above the Federal Reserve's (Fed’s) preference.

That brings us to the Fed’s preferred inflation gauge, the core PCE deflator. Unlike core CPI, this measure had actually been trending to the upside even on a pre-war basis. Indeed, the year-over-year reading now stands at +3.4% as of this writing. This figure is not only close to one and a half percentage points above the Fed’s target, but it is also at its highest reading since the fall of 2023.3

That brings us back to the energy component of the equation. Post-MOU news, energy prices have retreated more than we initially expected would be the case when hostilities came to a halt. In fact, as of this writing, nearby WTI crude oil has come close to retracing all of the war-related increase. Over the next few months, it seems highly likely that month-over-month Consumer Price Index (CPI) readings will begin to show this development.

However, from a core inflation perspective, a reversal from recent gains may encounter a few more headwinds. To be sure, the pass-through effects from higher energy prices to the broader macro landscape could linger and take more time to potentially reverse course. Demand pressures from the AI buildout perspective will remain a dominant force as well.

Either way, the Fed’s 2% target will more than likely continue to be elusive.

Fed Policy: Changing of the Guard

The June FOMC meeting will go down in history as marking a milestone event in U.S. monetary policy. Interestingly, it was not the decision to keep interest rates on hold or remove the easing bias per se, but it was Kevin Warsh taking charge as the new Fed Chair and placing his stamp on the future direction of how policymaking will occur and be communicated to the public. In fact, five task forces have been formed to do just that.

It is interesting to note that the changes Warsh referred to at the June presser should not have come as a surprise to investors. Forward guidance and the Fed’s balance sheet were clearly identified as two key areas the Chair would be looking at ahead of time. In a new twist of sorts, Warsh stated that some of the economic data used for policymaking decisions might be an “echo of history,” suggesting that decisions could be being made with flawed inputs. The Chairman emphasized he was “open-minded” about new data sources, particularly ‘real-time’ information.

While the Fed’s ‘Warsh out’ of forward guidance makes for interesting discussions, the bottom line still comes down to: Where are rates headed? The new Chairman’s emphasis on the Fed’s 2% inflation target was a clear sign that he will not be a rubber-stamp for rate cuts, and he also mentioned that, outside of housing, it’s “hard to say policy is restrictive.” While the labor market and inflation backdrops have shifted in a visible fashion compared to earlier this year, and have removed rate cuts from the discussion at the point in time, we still don’t see the Fed feeling an urgency to hike rates either.

Unless upcoming jobs and inflation data argue for a potential rate hike, our base-case scenario still sees the Fed on hold for the remainder of this year.

Searching for GeoAlpha

There has been no shortage of headline risks. But the Iran conflict was a bit different. There was the risk that oil prices would spike and remain sustainably higher. The knock-on effects were broad and potentially troublesome. Some of the risks materialized. Oil prices spiked, gasoline prices followed suit, and everything from plastics to fertilizer suddenly became a source of risk.

Fortunately, the vast majority of the issues are now largely mitigated. The conflict is no longer kinetic, and the documents are being negotiated for a permanent(ish) end to the hostilities. Oil prices have reverted back to pre-conflict levels, and there is a sense of relief that “it’s over”. Our outlook for the Iran conflict was that it would cause a temporary, sharp increase in inflation and fear of future inflation pressures. This has materialized in a meaningful for markets.

That is not, however, the look ahead at the moment. Oil prices are on the decline. Gasoline–though “up like a rocket, down like a feather”–will follow. Simply, the geopolitical risk of the Iran-Israel-U.S. conflict was priced in and then priced out in the space of a quarter. For better or worse, that is the way the geopolitical risks typically work. They are quickly priced in. And they are quickly priced out.

Where are the next headlines going to come from? That is always the question that matters most, albeit the most difficult to answer. Tariffs will make a comeback in some form or the other. That is a known, and round two is not to be as meaningful as round one. Companies have done a fantastic job of mitigating the effects of tariffs on their businesses, and the absolute tariff levels are lower from the first go around. This makes it less of a risk to earnings and something worth looking through.

Generally, the geopolitical risks should now pivot back toward where they were earlier in the year. The relationship of the U.S. and China, the AI revolution, and government investment across the technology stack. That is a refreshing turn from “headline risk to bottom line risk”, something investors should embrace.

1 Bureau of Labor Statistics, 7/2/26.

2 St. Louis Federal Reserve, 6/26/26.

3 Bureau of Economic Analysis, 6/26/26.