Stocks registered mixed performance last week as stronger than expected economic data, including an upward revision to second-quarter gross domestic product () growth to 3.8 percent, led some investors to fear that the Federal Reserve would be less aggressive with future cuts. As a fresh batch of inflation data brought few surprises, emboldened traders bought the dip as the Federal Reserve turned its gaze to a cooling job market.
The pace of core inflation remained little changed in August, according to a report from the Bureau of Economic Analysis (BEA) on Friday, showing that the Fed’s closely watched the core personal consumption expenditures () price index—which excludes more volatile food and energy costs—rose 0.23 percent in August compared to 0.24 percent in July.
We have consistently stated that the last leg of taming inflation will be the most difficult. Core PCE inflation has been stuck in a narrow range of 2.6–3.2 percent year over year since the end of 2023, with the current reading of 2.9 percent representing the highest rate since February. While that figure remains well above the Fed’s 2 percent target, it is also widely in line with recent economic forecasts—leaving many investors convinced that the Fed remains on track to further reduce interest rates. Federal funds futures are pricing in a nearly 90 percent possibility of an additional quarter-percent rate cut at the U.S. central bank’s October meeting and around a 73 percent probability of a third cut in December.
However, we continue to believe that the full economic impacts of tariffs have yet to materialize in the supply chain and caution against penciling in a certainty of future rate cuts. Federal Reserve Chair Jerome Powell warned the Greater Providence Chamber of Commerce in Rhode Island on Tuesday. A “reasonable base case” would be that the tariff-related effects on inflation will be relatively short-lived in the form of a one-time shift in the price level. But “a ‘one-time’ increase does not mean ‘all at once,’” he reminded the audience. “But uncertainty around the path of inflation remains high. We will carefully assess and manage the risk of higher and more persistent inflation. We will make sure that this one-time increase in prices does not become an ongoing inflation problem.”
While inflation remains above the Fed’s 2 percent target, the Fed’s focus is shifting to the labor market given its recent weakness. “You’ve got a low firing, low hiring environment. And the concern is that if you start to see layoffs, the people who are laid off—there won’t be a lot of hiring going on. So that could very quickly flow into higher unemployment,” Powell stated after the Fed’s September 17 meeting, when the U.S. central bank opted to cut its benchmark interest rate by a quarter-percentage point.
fell to a seasonally adjusted figure of 218,000 for the week ending September 20, according to the U.S. Department of Labor, a 14,000 drop from the previous week’s revised level. While the previous week’s numbers were revised slightly upward, the overall trend of decreasing claims is consistent, reflecting a “low firing” environment in which employers may lay off their existing workforce. The four-week moving average was 237,500, representing a 2,750 decrease from the previous week’s revised average in another sign of a stagnant employment situation.
On the other side of the coin nonfarm payrolls have averaged a low 27,000 jobs per month over the past four months, indicating a “low hiring” scenario in which much of those hires are occurring in the more noncyclical health care and social assistance industries. Furthermore, the nonfarm payrolls one-month diffusion index has hovered below 50 percent for four consecutive months, suggesting a further softening in the labor market. This has set up what Powell has previously called “a curious kind of balance” in which the demand for and supply of workers have declined simultaneously.
“In this less dynamic and somewhat softer labor market, the downside risks to employment have risen,” the central bank chair noted on Tuesday. “Near-term risks to inflation are tilted to the upside and risks to employment to the downside. … If we ease too aggressively, we could leave the inflation job unfinished and need to reverse course later to fully restore 2 percent inflation. If we maintain restrictive policy too long, the labor market could soften unnecessarily.”
These risks have already begun to show up in the data. U.S. dropped to a four-month low of 55.1 in September, according to data from the University of Michigan on Friday, down from a preliminary reading of 55.4 earlier this month and 58.2 in August. The drop-off reflects concerns over both rising inflation and a softening labor market as consumers absorb mixed messages about the economy. Sixty-five percent of respondents expected more unemployment in the coming months; a historical reading resembling levels observed only during periods of economic contraction. At the same time, consumers expect five- to 10-year inflation to come in at 3.7 percent, the highest inflation expectations observed since June of 1993 (excluding the period between May 2025 to present day), a period when core inflation was moving lower from the heighted inflationary period of the 1970s and ’80s.
How should investors respond to this uncertain and odd period where risks from inflation are elevated at the same time the labor market appears to be weaking? As discussed in our Asset Allocation Focus, it has become clear that the “economic tails”, or the range of possible outcomes, are wider than normal. The good news is that our investment philosophy acknowledges these tails, factoring in various outcomes by prioritizing diversification over concentration.
Let’s dive further into this week’s data.
Wall Street Wrap
Economic growth proves resilient: The U.S. economy grew stronger in the second quarter than previously estimated, according to the BEA, after was revised higher. The upward revision to consumer spending was fueled by increased transportation, financial services and insurance, according to the agency, and was partially offset by a downward revision to exports. GDP grew at an annualized rate of 3.8 percent in the three months ended in June 2025, the BEA said on Thursday in its third reading of second-quarter figures. Consumer spending was also revised higher, up to an annualized 2.5 percent versus 1.6 percent in the prior reading. First-quarter growth was revised lower to a 0.6 percent contraction, however.
Manufacturing and services weaken slightly but remain strong: Despite rising inflation and tighter margins, the composite S&P Global US PMI Composite Output Index fell to 53.6 in September from 54.6 in August, indicating that the third quarter of 2025 has seen the strongest average monthly expansion since the fourth quarter of 2024.
“Further robust growth of output in September rounds off the best quarter so far this year for U.S. businesses. PMI survey data [is] consistent with the economy expanding at a 2.2 percent annualized rate in the third quarter,” said Chris Williamson, chief business economist at S&P Global Market Intelligence.
However, the underlying data of the report also reflected continued inflationary pressures that are squeezing corporate margins, setting up the potential for a further weakening of the job market.
Tariffs were once again cited as the main cause for cost increases in September. Manufacturing input cost inflation remained elevated at one of the highest rates since the pandemic, according to the preliminary data, albeit dipping slightly since August. Service-sector inflation, meanwhile, hit the second-highest figure recorded over the past 27 months, exceeded only by that of May 2025.
Despite rising input cost inflation, average prices charged for goods and services advanced at the slowest pace since April. Companies reported difficulty passing on elevated costs to consumers amid wavering demand and fiercer competition, squeezing margins and placing additional pressure on the job market.
Inflation remains sticky: Overall inflation rose 0.3 percent month over month in August and is now up 2.7 percent on a year over year basis. Core inflation rose 0.23 percent and is up 2.9 percent year over year. In a further sign of stickiness, core inflation is up 2.9 percent at a three-month and nine-month annualized pace. Goods inflation, rose 0.13 percent in August, reflecting the gradual impact from tariffs with 6 out of 8 months this year being positive. While goods inflation remains modest at 0.9 percent on an annual basis, it represents the fastest pace since September 2023. Services inflation continues to remain sticky, up 0.32 percent month over month.
Consumer spending remains resilient despite stubborn inflation: Sticky inflation was little match for consumer spending, however, which gained 0.6 percent in August in a show of strength against tariffs. The personal saving rate decreased in August to 4.6 percent, however, down from an upwardly revised 4.8 percent in July.
New home sales rise: rose to a seasonally adjusted annual rate of 800,000, the fastest pace since 2022, following the Fed’s move to cut interest rates. As mortgage rates fell, a lack of existing homes on the market pushed buyers toward new construction, and home builders offered incentives such as mortgage buy-downs and upgrades.
“Following the Fed’s actions in September, mortgage rates fell to 6.18 percent from 6.5 percent in August,” said Jing Fu, director of forecasting and analysis for National Association of Home Builders (NAHB). “However, new home sales will likely weaken in October due to a recent rise in long-term rates.”
Existing home sales fall: remained relatively unchanged in August, according to the National Association of Realtors, decreasing by 0.2 percent in August to a seasonally adjusted annual rate of 4 million units.
“Home sales have been sluggish over the past few years due to elevated mortgage rates and limited inventory,” said National Association of Realtors (NAR) Chief Economist Lawrence Yun. “However, mortgage rates are declining, and more inventory is coming to the market, which should boost sales in the coming months.”
“Record-high housing wealth and a record-high stock market will help current homeowners trade up and benefit the upper end of the market. However, sales of affordable homes are constrained by the lack of inventory,” Yun added. “The Midwest was the best-performing region last month, primarily due to relatively affordable market conditions. The median home price in the Midwest is 22 percent below the national median price.”
The Week Ahead
Wednesday: The Institute for Supply Management () will release its latest Purchasing Managers Manufacturing Index at 10am EST. August’s reading saw manufacturing contract for the sixth consecutive month, albeit at a slower pace than in previous months. We will be watching to see if manufacturing activity continues to contract at a slower rate or perhaps reverses course following the Fed’s latest cut to interest rates.
will also release its September National Employment Report in collaboration with Stanford Digital Economy Lab. Private employers added only 54,000 jobs in August compared to 104,000 jobs in July, failing to meet the +68,000 consensus.
Thursday: Initial and will be out before the market opens. We’ll be watching to see if the trend of falling initial and continuing claims discussed in last week’s Market Commentary continues, which could add further downside risks to the labor market.
Providing more key insights into the labor market, the Challenger Job Cut Report for September will become available at 7:30 a.m. EST. Last month’s report showed that U.S.-based employers announced 85,979 job cuts in August, up 39 percent from the 62,075 announced in July. As of August, companies had announced 892,362 job cuts, the highest YTD figure since 2020.
Friday: The will release its Services Purchasing Managers Index for September. The index rose from 50.1 to 52.0 in August, the highest level observed since February following a contraction in July. Given that this series has a correlation with future services inflation, we will be looking to see if this modest rebound in services activity continues to give us a better idea of where inflation is headed next.
Additionally, the Bureau of Labor Statistics will release its September at 8:30 a.m. EST. We’ll be paying close attention to see if last month’s notably weak U.S. payrolls data continues, which weighed heavily into the Fed’s decision to cut rates by a quarter-percentage point earlier this month and reinforced its theory that the labor market is becoming a growing risk factor in terms of inflation. A further softening in the labor market could increase the likelihood of an additional rate cut in October and a third 25-basis-point cut to come later this year.