A SHIFT IN FOCUS

On top of the extremely weak monthly jobs report released last week, this week’s initial jobless claim data showed the number of people filing new claims for unemployment insurance rising to 263,000, representing a rise of 27,000 from the prior week and the highest level of initial claims since October 2021. The continuing claims data, which is the number of people receiving unemployment benefits after the initial week, remained steady at roughly 1.939 million. Further, the government noted this week that the monthly jobs report may have been overstated by 911,000 jobs in the 12-month period through March 2025, so conditions were not as strong as had been presented. The deterioration in the labor market continues to gain attention from Fed officials, and Fed Chair Powell recognizes that a weak labor market leads to a weak economy. 

We believe that the U.S. economy will avoid a recession, but we anticipate that this economic soft patch may persist into 2026. The risk is to the downside here, with the potential that what is, today, only softness in the labor market becomes something more severe, manifesting in job losses and layoffs. That is not our base case, but it is certainly something worth watching.

August data suggests that inflation remains sticky. Headline CPI was hotter than consensus estimates, coming in at an annualized rate of 2.9% — an increase from last month’s 2.7% rate. Shelter costs were the culprit for the acceleration. The Fed focuses on core inflation, and August core CPI increased in line with consensus to an annualized rate of 3.1%. Core services inflation remained firm, with airfare prices rising demonstrably, and core goods inflation reflected some tariff-related impacts, particularly in apparel and in new and used auto prices. The balance between goods and services inflation will be important to monitor, specifically in light of potential tariff impacts. 

Since the year-over-year inflation rate peaked at 9.1% in 2022 in the midst of the global pandemic, it has been the disinflation in the goods sector that has offset some of the inflation on the services side of the economy, contributing to the overall cooling in inflation. If we experience a tariff-related reversal in goods inflation while we continue to see upward price pressure in services, the meaningful progress made on inflation to date could backslide. However, we think labor-market weakness will temper service sector inflation and ultimately result in inflation continuing to fall — although at stutter-step pace. 

U.S. risk assets have continued their march upward. The S&P 500 and the NASDAQ notched record highs this week, and the Russell 2000 small cap index rose to within 1% of its record high set in 2021. U.S. growth stocks have rallied, with this week’s news from Oracle adding fuel to the AI fire.

Oracle revealed that it had signed multi-billion-dollar cloud contracts with AI firms, including Open AI, Meta and xAI. The biggest impact was from Oracle’s $300 billion, five-year deal with OpenAI for computing power and infrastructure. That news sent the stock soaring over 30% and brought the market capitalization of the company closer to the $1 trillion level. A handful of U.S. companies continue to dominate popular market benchmarks, with the top 10 companies by market capitalization now representing just under 40% of the entire S&P 500. The “MAG 7” alone also represents nearly 40% of the performance of that benchmark year-to-date and continues to dominate from an earnings growth perspective.

We agree with the market’s perspective on the path of the fed funds target rate, with two to three cuts expected this year and an additional two to three in 2026. Monetary policy easing — especially if it occurs outside of a recession — is a good environment for risk taking, and should provide a tailwind to risk assets. With a forecast for an economic soft patch without a recession and for solid corporate earnings, we continue to recommend investors remain fully invested in their goal-aligned asset allocations.

Key to this outlook is the resilience of the economy and fundamentals. Labor demand is certainly slowing; however, we see a slowdown in labor supply resulting from tighter immigration policies having an impact. That may keep a weaker labor market more in balance than in prior periods and may prevent a slowdown from becoming something deeper or more protracted. At the same time, we have been impressed already with the resilience of corporate fundamentals in spite of policy volatility, and we anticipate that lower interest rates will provide an additional support to earnings in 2026.