Q3 Economic Outlook: Fed Policy, Labor Market Trends, and Inflation

Third Quarter Economic Outlook  

Six months ago, the consensus was that the Federal Reserve would cut interest rates twice this year. Today, the Fed’s own projections point to a rate hike instead. That’s a meaningful shift. What’s driving that change and what does it mean for your portfolio? 

Let’s Start With the Good News.  

The economy is on solid footing heading into the second half of the year. Growth rebounded in the first quarter to a 2.1% annualized rate, and consumer spending has held up well, even as sentiment stays cautious. Unemployment is still relatively low at 4.2%.  

But There are Cracks Worth Watching 

The June jobs report was soft. Employers added just 57,000 jobs, well below expectations, and the prior two months were revised down. The unemployment rate actually dipped, but for the wrong reason: people are leaving the workforce due to not finding jobs. So the labor market is cooling, even if the headline number looks fine.  

Then there’s inflation. Headline inflation ran at 3.5% year-over-year through June, well above the Fed’s 2% target, driven largely by higher energy prices tied to tensions in the Middle East. The encouraging part is that core inflation, which strips out the more volatile sectors of food and energy, came in more subdued at 2.6% year-over-year.  

That Backdrop Set the Stage for the Bigger Story 

In May, Kevin Warsh was sworn in as the new Chair of the Federal Reserve, and he signaled that change is coming. At his first meeting, he launched five task forces to reexamine how the Fed communicates, manages its balance sheet, and thinks about inflation and employment. Taken together, it points to a rethinking of assumptions that have guided policy for two decades.  

Conclusion 

So what does this mean for you? Less than the headlines suggest. A hawkish Fed and a cooling labor market are worth watching, but they don’t call for dramatic moves in a well-built portfolio. Times like these are exactly why we diversify and stay disciplined, rather than trying to guess the Fed’s next step. If you have any questions about how the economy may impact your portfolio, please don’t hesitate to reach out to your advisor.