The third quarter opened with the Federal Reserve’s first expected rate cut sliding further into 2027 and an economy warming at the top line while the workers inside it felt none of it. It closed with a unanimous quarter-point increase, crude near $110 a barrel and consumer confidence at its lowest level since April 2014. In 90 days the governing question moved from when the easing would begin to how many increases the year still holds.

The deeper story was about a central bank that stopped looking through supply shocks. Three of them overlapped through the quarter: an energy crunch that reopened in July and worsened in September, an artificial intelligence (AI) buildout that lifts investment and imports in nearly equal measure and the residue of tariffs. For most of the past two years the committee treated disturbances of this kind as noise to see past. By the end of September, it had decided otherwise, and the decisive input was not a wage number or an output gap but a damaged pipeline in Saudi Arabia. The quarter also closed with a set of annual revisions that made the recent past look better in almost every respect and changed the path ahead not at all.

Executive Summary

• Rates are on the rise. The Federal Open Market Committee (FOMC) held the policy rate at 3.5% to 3.75% in July on a 9-to-3 vote, with three regional Federal Reserve presidents dissenting in favor of an increase, then raised the rate 25 basis points to a range of 3.75% to 4% in September, unanimously, with the projections pointing to risk management rather than overheating as the motive.
  
• Energy struck twice. The collapse of the United States-Iran truce reclosed the Strait of Hormuz in July and pointed retail gasoline back toward $4.50 a gallon, and September damage to Saudi Arabia’s East-West pipeline, the critical alternate route for Middle East crude, sent oil close to $110 a barrel. Diesel became the most consequential price in the economy at $6.50 a gallon, a level consistent with crude at $156, with tightness in refined products capable of adding as much as four tenths of a point to core inflation next year.
  
• The labor market maintained its equilibrium. The labor market stopped hiring without starting to fire. Nonfarm payrolls fell 23,000 in July before rising 162,000 in August, while the layoff rate slipped to 1.0% and the hiring rate held near 3.3%.
  
• Annual inflation revisions rewrote the recent past favorably. Core Personal Consumption Expenditures (PCE) inflation now runs at 3% rather than the pre-revision 3.3%, growth in 2024 and 2025 came in two tenths higher with most of the gain in AI-exposed categories, and the personal saving rate moved up by more than 1.5 points to above 4%.
  
• The consumer maintained its split personality. Households spent well and felt terrible. Confidence fell to 81.9, its weakest since April 2014, sentiment finished the quarter at 48.1 with year-ahead inflation expectations at 4.6% and the third quarter nowcast for consumption still ran at 3.3% annualized.
  
• AI giveth and taketh away. The AI buildout kept adding to activity and subtracting from measured output, with capital goods imports up 57.2% over the year and net trade on track for a 3-percentage point drag on third-quarter growth, the largest since the first quarter of 2025.

The Fed: From Waiting to Hiking
No institution traveled further this quarter than the Federal Reserve, and it traveled in the direction nobody had penciled in. July opened with the first expected cut sliding toward the back half of 2027, pushed there not by a cracking economy but by a steady one that gave the committee no reason to hurry. At the July 29 meeting the committee held at 3.5% to 3.75%, and the vote told the more interesting story: 9 to 3, with three regional Federal Reserve presidents dissenting in favor of an increase, against market pricing of roughly a one-in-three chance of a hike, which sent Treasury yields sharply lower once the decision landed. A committee that argues loudly and then leaves the thermostat alone is still a committee that has moved, if only in temperament.

Jackson Hole was the hinge. Chair Kevin Warsh used his keynote to reaffirm 2% inflation on the PCE measure as a firm, fixed target. After months of studied ambiguity, the implication from the Chair is that policy settings were not restrictive, a departure from the language of his predecessor and from a dot plot placing the policy rate above the longer-run neutral level, and that underlying inflation was moderating too slowly. Markets did the rest, moving the September decision to a coin toss from roughly one-in-three odds and pricing two increases over the coming year. A chair who declines to give forward guidance had moved the rate path further with one speech than most predecessors had managed with a statement.

September delivered what August had implied. The committee raised the policy rate a quarter point to a range of 3.75% to 4%, unanimously, with the projections suggesting risk management rather than an overheating economy as the motive and with several participants lifting their estimate of the neutral rate, which amounts to conceding that policy had never been as tight as they supposed. Warsh defended the decision by naming three developments, and one of them was not an economic statistic at all, since alongside higher energy costs and a labor market that had stopped worrying him he cited the geopolitical flare-up in the Middle East.

The structural revision matters more than the next meeting. The path now runs to a cutting cycle spread across 2028 that arrives at a new and higher neutral rate of 3.25% to 3.5% A change that reflects stronger productivity growth, AI-driven investment demand and persistently large federal deficits that is likely to keep longer-term Treasury yields elevated on its own. Markets have run further still, pricing 90 basis points of tightening over the coming year, which Oxford Economics doubts the committee will deliver. The quarter therefore ends with the same disagreement it spent September resolving, only shifted one increase to the right.

• Key Takeaway: The Fed spent the first half of the quarter finding reasons to wait and the second half finding reasons to move, and the trigger came from outside the domestic economy entirely. What changed durably is the level around which policy settles, since a higher neutral rate is likely to keep long yields elevated regardless of how many increases December brings.

Energy: Two Shocks in One Quarter
The energy story that Q2 closed on a note of relief reopened within days of the new quarter. The truce between the United States and Iran fell apart in early July, the Strait of Hormuz closed again and wholesale prices pointed retail gasoline back toward $4.50 a gallon after weeks of improvement. By the end of July gasoline had climbed back above $4, keeping upside risk to inflation alive at precisely the moment the committee would have preferred a quiet summer.

September brought the larger blow, and it arrived from infrastructure rather than diplomacy. Damage to the East-West pipeline in Saudi Arabia, which had served as the critical alternate path for Middle East oil exports since the Strait closed, pushed crude close to $110 a barrel and looked to keep prices higher for longer. This had economists reworking their baseline forecasts, lifting West Texas Intermediate forecasts to an average above $100 a barrel in the fourth quarter against $80 previously. A single length of pipe moved the oil forecast by more than twenty dollars a barrel, which is a useful reminder of how little of the macro outlook the macro data actually contain.

The most dangerous price was not crude but diesel. It reached $6.50 a gallon, a level consistent with an oil price of $156 a barrel, a gap that speaks to an extraordinary refining spread and that will persist while tanker traffic through the Strait runs far below normal. Diesel matters more than gasoline for the inflation outlook because it sits inside the cost of producing and shipping ordinary goods and feeds directly into grocery, restaurant and delivery prices. Tightness in refined products could add as much as four tenths of a percentage point to core inflation next year. The proposed remedy carries its own hazard, since a ban on diesel exports would lower prices on the Gulf Coast and in the Midwest while raising them in the Northeast and on the West Coast, and would risk cutting refinery output and lifting gasoline prices. Hopefully, the measure is unlikely to occur.

The forecast arithmetic followed directly. The revised baseline carries headline Consumer Price Index (CPI) inflation as much as four tenths higher and nudges core CPI up a tenth, with food inflation now peaking later in 2027 and the additional energy passthrough to core prices running mainly through non-energy consumer goods and airfares. Firmer prices arrive paired with slightly slower growth, at 2.1% this year and 2.4% next, each a tenth below the estimate at the start of September.

• Key Takeaway: The quarter contained two separate energy shocks, one diplomatic and one physical, and the second proved worse than the first. Diesel is the variable that carries the shock into everything else, and it is the reason a supply disruption half a world away now shows up in a domestic policy rate.

Inflation: The Round Trip That Did Not Finish
Inflation spent the quarter looking as though it had turned the corner, right up until it did not. June brought a benign reading, with headline CPI falling 0.4% and the annual rate dropping to 3.5% from 4.2% while core prices came in flat, showing little of the tariff or AI passthrough the committee had watched for. July was nearly as kind, with headline CPI up 0.1% and core up 0.2%, leaving core running at 2.5% over the year. Two months of that sort of data is the stuff of which patience is made.

August ended it. Core CPI surprised to the upside at 0.3% with headline CPI up 0.4%, and the strength sat in non-housing core services, the category the Fed watches most closely because it reflects domestic demand rather than imported costs. Airfares, motor vehicle maintenance and repair, lodging away from home and wireless telephone services all accelerated together, which is the pattern energy costs leave behind when they stop being an energy story and become a services story.

Then the statisticians intervened. The Bureau of Economic Analysis (BEA) annual update of the national accounts revised measured core PCE inflation down by roughly three tenths, leaving it at 3% rather than the pre-revision 3.3%, on methodological improvements to three contested categories: computer software and accessories, portfolio management and legal services. The bulk of the improvement sat in portfolio management and investment advice fees, which rise and fall with stock prices and which Fed officials had already discounted in favor of the market-based PCE index. Getting a better thermometer is genuinely useful. It does not make the room any cooler.

Which is why the revision changed the record without changing the outlook. Core inflation still sits well above target with risks stacked firmly to the upside because of refined petroleum prices, and higher energy prices is projected to keep inflation tracking above 3% through the first quarter of 2027. The quarter thus ends with the curious result that inflation was lower than everyone believed and the Fed tightened anyway, which is what happens when a central bank starts managing the distribution of outcomes rather than the central case.

• Key Takeaway: Two benign months gave way to a firm August and then to revisions that lowered the entire recent history of core inflation. None of that resolved the underlying problem, since the level remains too high and the energy passthrough still ahead of us points in one direction only.

The Labor Market: The Expansion That Forgot to Hire
The labor market spent the quarter delivering the same message in progressively stranger ways. July payrolls fell 23,000 against a forecast gain of 80,000, though a 50,000 drop in state and local government employment accounted for the entire decline while private payrolls still rose 30,000. August then produced 162,000 against a consensus of 55,000, with July’s reported decline flipping to a 21,000 gain and the three-month average climbing to 71,000. Two months, two opposite headlines, one unchanged trend.

The reason those headlines meant so little is that the yardstick kept shrinking. A dwindling pool of available workers dragged the breakeven pace of hiring, the monthly job growth needed to hold the unemployment rate flat, toward 20,000 in the second half of the year, low enough that a negative print carries almost no information. The preliminary annual benchmark revision then trimmed 79,000 from the March level of payrolls, a rounding error beside the 861,000 final revision for 2025, and in nine of the past ten years the final revision has landed more positive than the preliminary estimate. Measuring this labor market against a fixed standard is like weighing yourself on a scale that recalibrates each morning.

The mechanism underneath deserves more attention than it received. This year’s improvement ran almost entirely through falling layoffs rather than rising hiring, with the layoff rate slipping to 1.0% in August from 1.1% while the hiring rate managed only 3.3% from 3.2%, inside the depressed 3.1% to 3.5% band of the past two years. The quits rate held at 1.9%, which is what workers do when they doubt they could find something better. Claims confirmed the calm, touching 187,000 in July, the lowest level since 1969, a figure that predates the microprocessor, and September closed with private payrolls in the Automatic Data Processing (ADP) report up 90,000 while the three-month average held at 57,000, close to breakeven. With layoffs already at historic lows, any further warming has to come from hiring, and hiring is the part that energy costs and tighter credit reach first.

For policy, the wage numbers mattered more than the payroll numbers, and they cooled all quarter. Average hourly earnings growth eased to 3.1% over the year while the Oxford Economics wage tracker fell below 3% for the first time in five years. Slower labor force growth is projected to hold the unemployment rate near 4.2% through 2027, which leaves the labor market as the one part of the inflation debate that never became an argument.

• Key Takeaway: The quarter produced a negative payroll month, a strong one and a downward benchmark revision, and none of the three changed the picture of a market balanced at a very low level of churn. Labor never threatened the inflation outlook, which is precisely why the shocks that did came from outside it.

The Consumer and Housing: Stronger on Paper, Sourer in Practice
Households spent the quarter behaving better than they felt, and the gap between the two widened every month. Second-quarter consumption grew a resilient 3.2% annualized on the advance estimate, trimmed later to 2.9%, July retail sales dropped 0.6% on seasonal distortion around a shifted online shopping event and August recovered with a 1.2% gain led by discretionary categories. By quarter-end, after revisions, the third quarter nowcast for consumption ran at a 3.3% annualized pace against 2.8% previously.

The revisions improved the foundation as well as the flow. The personal saving rate moved up by more than 1.5 points to above 4%, meaning households entered the energy shock with a materially larger cushion than anyone had credited them with, and gross domestic income came in higher on new and much larger estimates of net interest income, which leaves recent spending resting on firmer ground than the pre-revision data implied.

None of which the consumers noticed. The University of Michigan sentiment index finished September at 48.1, with the expectations component down 10% for its largest decline since April 2025, and year-ahead inflation expectations jumped six tenths to 4.6%, above the 3.4% level that prevailed before the war. The Conference Board measure fell to 81.9 from 88.6, the weakest reading since April 2014, when the index was still climbing out of the Great Recession. Its labor differential, the gap between those calling jobs plentiful and those calling them hard to get, dropped 2.5 points to 1.7, the lowest since February 2021, which says less about layoffs than about how it feels to look for work when nobody is hiring.

Housing was the clearest casualty of the rate path. Mortgage rates climbed more than 30 basis points over the final month toward 7%, homebuilder sentiment fell three points to 32 on deteriorating current and expected sales and existing home sales slipped 2% in August to 3.98 million, down 1.2% from a year earlier. Prices offered a last piece of good news that reads like a peak, with the national index up 1.9% over the year in July, the largest annual gain since June 2025, though favorable base effects have now passed and the 2027 price forecast is due for a markdown, since rates above 7% price buyers out even as they keep sellers on the sidelines.

• Key Takeaway: The revisions made the household balance sheet look considerably better, and confidence fell to a twelve-year low anyway. Spending is carried by the households that own assets, while the households that buy gasoline set the tone of the surveys and housing absorbs the full cost of a rate path neither group chose.

The AI Economy: Adding More, Netting Less
The through-line of the quarter, as of the two before it, was artificial intelligence. Core capital goods orders rose 1.6% in August on solid gains across primary metals, machinery and electrical equipment, keeping the forecast for equipment spending to expand 10.7% in 2026, the strongest annual pace in more than a decade. Corporate profit margins sit at all-time highs, business inventories remain lean and the tailwind from AI keeps broadening from information-processing equipment into machinery and metals, which is why higher financing costs have not yet bitten.

The same buildout keeps punishing the trade account. The advance goods deficit widened $13.7 billion to $132.6 billion in August, the largest since the first quarter of 2025, as imports climbed 5.5% against a 1.9% rise in exports, putting net trade on track to subtract 3 percentage points from third-quarter growth. Capital goods imports now stand 57.2% above year-ago levels, and the strength has begun to broaden, with all other imports up 11.8% over the year, their fastest since March 2025. A country that buys the hardware abroad and books the spending at home may continue to see the two largely cancel.

The annual revisions finally gave the buildout some statistical credit. Growth in 2024 and 2025 came in two tenths higher, with most of the revision in business fixed investment and roughly two thirds of that concentrated in categories sensitive to AI, including information technology equipment, research and development and data center investment. The third estimate of second-quarter output rose to 2.2% annualized from 1.5%. Taken with the downward revision to measured inflation, the message is that AI has been adding more to growth and less to prices than the data previously showed, which is close to the opposite of how the debate ran for most of the year.

The dependency is the part to keep in view. The revisions do not change the perception that the economy leans increasingly on AI gains and on the wealth effects that lift higher-income spending, which leaves it sensitive to a sudden reversal of optimism. There is a more hopeful reading available as well, since stronger measured productivity could shift the conversation from what AI does to inflation toward what it undoes, with disinflationary effects that may show up more prominently in 2027. Both readings rest on the same assumption, which is that the capital keeps flowing.

• Key Takeaway: AI drove the investment cycle, the import surge and after revisions, a meaningful share of the growth the economy turned out to have had all along. The concentration cuts both ways, since the same force that has carried three quarters of expansion is the one whose reversal would be hardest to replace.

Final Thoughts
The third quarter of 2026 will be remembered as the quarter the Federal Reserve stopped waiting. It began with the first expected cut sliding toward the back half of 2027 and ended with a unanimous increase and another penciled in for December, and the decisive event was neither a wage spiral nor an overheating consumer but a damaged pipeline in Saudi Arabia that took crude toward $110 and diesel to a level implying $156 crude. Underneath the policy drama the economy performed better than it felt, with the labor market balanced at a very low level of churn, wage growth below 3% and annual revisions that raised past growth, lowered measured core inflation to 3% and lifted the saving rate above 4%. The unfinished business is the energy passthrough still working its way into core prices, a consumer whose confidence sits at a twelve-year low while spending holds and an expansion that depends on an AI capital cycle it could not easily replace. The fourth quarter will test whether a central bank that has learned to react can avoid overcorrecting for a disruption that monetary policy was never able to fix, and whether an economy that has absorbed three shocks in nine months has any absorption left.

Oxford Financial Group, Ltd. is a SEC-registered investment adviser. Registration does not imply a certain level of skill or training. The information provided is for general informational purposes only and should not be considered investment, tax or legal advice. Opinions are those of the author and are subject to change based on market, regulatory or economic conditions. Forward-looking statements are opinions and/or estimates and are not guarantees of future results. Data and opinions are based on sources believed to be reliable, including unaffiliated third parties such as Oxford Economics, but their accuracy cannot be guaranteed. Past performance is not indicative of future results. See important disclosures and disclaimers at https://ofgltd.com/home/disclaimers. OFG-2610-07

The last letter called the September meeting a coin toss and declined to flip it. The committee flipped it, unanimously, with a quarter-point hike delivered less because the economy was overheating than because a damaged pipeline in Saudi Arabia had made the inflation outlook unrecognizable. What followed over the next ten days was a wholesale revision of nearly every forecast that mattered, and a central bank that now sets policy with one eye on the Strait of Hormuz.

Executive Summary

• The Federal Open Market Committee (FOMC) voted unanimously to raise the policy rate 25 basis points to a range of 3.75% to 4%, with the accompanying projections suggesting risk management rather than overheating as the motive.
• Damage to the East-West pipeline in Saudi Arabia, the critical alternate route for Middle East crude since the Strait of Hormuz closed, sent oil close to $110 a barrel, and forecasters now look for West Texas Intermediate to average over $100 per barrel in the fourth quarter against $80 in the first September baseline.
• Diesel at $6.50 a gallon implies an oil price of $156 a barrel, and tightness in refined products could add as much as four tenths of a point to annual core Personal Consumption Expenditures (PCE) inflation in early 2027.
• The revised baseline carries headline Consumer Price Index (CPI) inflation up to four tenths higher with core CPI a tenth higher, and projected to trim real growth to 2.1% this year and 2.4% next, each a tenth lower than at the start of the month.
• Third-quarter growth is tracking just under 4% annualized, with inventories alone contributing 1.8 percentage points and equipment spending another 0.9 point.
• Consumer sentiment fell to 48.1 in September from 51.7, with the expectations component down 10%, its largest decline since April 2025, while year-ahead inflation expectations jumped six tenths to 4.6%.
• Mortgage rates have climbed more than 30 basis points over the prior month toward 7%, and homebuilder sentiment fell three points to 32, further below the line that separates healthy conditions from poor ones.

The Fed: A Hike, and a New Reaction Function

The committee raised rates by a quarter point to a range of 3.75% to 4%, and the vote was unanimous. The accompanying projections pointed to risk management rather than an overheating economy as the motive. The proximate causes were the hotter August inflation readings and the continued climb in energy prices, which together skewed the risks toward inflation staying higher for longer, helped along by an economy resilient enough that participants lowered their unemployment projections. Several participants also raised their estimate of the neutral rate, which amounts to conceding that policy had not been as tight as they had supposed.

Chair Kevin Warsh defended the decision by naming three developments, and one of them was not an economic statistic at all: higher energy costs, a labor market that has stopped worrying him and the geopolitical flare-up in the Middle East. He again declined to offer forward guidance, though the Summary of Economic Projections said plenty on his behalf, showing almost all officials placing the risks to inflation to the upside and the risks to unemployment broadly balanced, the most hawkish arrangement in some time. A chair who refuses to tell markets what he will do has now told them something more useful, which is what he is watching. The September move will not stand alone. The second release of the September baseline pencils in another increase in December followed by an extended pause through next year, even as markets price more tightening than the committee itself projects.

The deeper change concerns how the Fed decides anything. In a world prone to adverse supply shocks, central banks will grow steadily more reactive to geopolitical stress that can unsettle inflation expectations, and the committee now appears to be done arguing over whether to look through an oil or tariff shock the way it historically would. Iran is not the only pressure point. President Donald Trump hosted Chinese leader Xi Jinping in Washington, with attention on any shift in rhetoric over Taiwan, where a genuine confrontation would amount to a global supply shock and send electronics prices higher with spillovers across the rest of the basket. Monetary policy has always responded to events. What has changed is that the events now arrive by tanker.

• Key Takeaway: The Fed hiked because the supply side moved, not because demand overheated, and it has effectively adopted a reaction function that treats geopolitical risk as a policy input. A December increase looks likely, markets are priced for more than that and the honest position is that nobody can forecast a pipeline caught in geopolitical turmoil.

Energy: The Shock That Set the Rate

One piece of infrastructure did most of this fortnight’s work. Damage to the East-West pipeline in Saudi Arabia, which had served as the critical alternate path for Middle East oil exports since the Strait of Hormuz closed, pushed crude close to $110 a barrel and will keep prices higher for longer while delaying any disinflation in import prices. This resulted in a full reworking of the September baseline, lifting the West Texas Intermediate forecast to an average of $103 a barrel in the fourth quarter from $80, with prices also higher in 2028 and 2029 on a more persistent risk premium. Risks run both ways: (1) strikes on the Ras Tanura ports and Kharg Island would take oil toward $130 in the fourth quarter, (2) on the other hand prices have already eased somewhat as Saudi Arabia found a workaround for Asian refiners and as the prospect of faster pipeline repairs took the edge off.

The more alarming price is the one nobody quotes on television. Diesel has climbed to all-time highs, and its second-round effects worry economists more than a comparable move in gasoline, because diesel sits inside the cost of producing and shipping ordinary goods and feeds directly into grocery, restaurant and delivery prices. At $6.50 a gallon, diesel implies an oil price of $156 a barrel, a gap that speaks to an extraordinary crack spread and will persist as long as tanker traffic through the Strait stays far below normal. Tightness across refined products could add as much as four tenths of a percentage point to annual core PCE inflation by early 2027. The policy response carries its own hazard: the White House floated the notion of a 90-day ban on diesel exports, which would force refiners to cut runs and push gasoline and jet fuel higher, while risking agricultural disruption in Latin America that would return home as costlier imported food.

Import prices had already turned before the latest surge showed up in any data. They rose 0.7% in August, with nonfuel prices up 0.8% accounting for the entire increase and fuel prices down a tenth for a third consecutive monthly decline, leaving the annual rate at an elevated 7%. Buried in the detail sits a reminder that energy is not the only supply story running: computer accessories rose more than 5% on the month against a 2% decline in the August CPI, a divergence that the AI infrastructure buildout should keep alive.

The forecast arithmetic follows directly. The revised baseline carries headline CPI inflation as much as four tenths higher and nudges core CPI up a tenth, with food inflation now peaking later in 2027 and at a higher rate, and the additional energy passthrough to core prices running mainly through non-energy consumer goods and airfares. Firmer prices come paired with slightly slower growth, as real output is now expected to expand 2.1% this year and 2.4% next, each tenth below the estimate at the start of the month. There is one consolation on the measurement side. The Bureau of Economic Analysis releases annual revisions that should lower measured core PCE inflation in the second quarter by two tenths, enough to ease inflation anxiety at the central bank without erasing it.

• Key Takeaway: A single damaged pipeline reset the oil forecast by more than twenty dollars a barrel and pulled the inflation profile up with it. Diesel is the variable to watch, since it travels into the price of nearly everything, and a proposed export ban would treat the symptom while worsening the disease.

Growth: Four Percent, Improbably

Set against all of that, the economy is having one of its better quarters. Third-quarter growth is tracking just under 4% annualized, a figure that owes more to arithmetic than to animal spirits. Headline retail sales rose 1.2% in August against an above-consensus estimate of 0.9%, with much of the strength found in a rebound in nonstore sales after the shifting timing of a major online shopping event distorted July, and with rising pump prices flattering gasoline station receipts; even allowing for that, gains were decent across most categories, led by food services, electronics and sports and recreation. Feeding that through Oxford Economics nowcast puts real consumer spending at a 2.8% annualized gain for the quarter, well above the 1.9% in the September baseline.

The second contributor is restocking. Business inventories rose 0.8% in July on strong gains in retail and wholesale, with the inventory-to-sales ratio down to 1.3 from near its decade average of 1.37 a year earlier, and the nowcast puts inventories alone at a 1.8 percentage point boost to third-quarter growth. The catch is that the energy shock attacks this channel directly, since higher transport and borrowing costs raise the expense of holding and financing unsold goods, and firms with heavy cross-border links to Canada, the automotive sector among them, now face markedly higher tariffs.

Equipment spending supplies the third leg and looks the most durable of the three. Durable goods orders held unchanged in August against a consensus decline of 0.3%, and the standout was a 1.6% rise in nondefense capital goods orders excluding aircraft, with solid gains across primary metals, machinery and electrical equipment, which keeps the forecast for equipment spending to expand 10.7% in 2026, the strongest annual pace in more than a decade. Shipments, which are what actually reach gross domestic product (GDP), slipped 0.2% and trimmed the tracking estimate for third-quarter equipment investment to a 16.1% annualized pace from 17.6%, still leaving equipment to contribute 0.9 points to growth. Corporate profit margins sit at all-time highs, and the AI buildout keeps broadening from information-processing equipment into machinery and metals, which is why higher financing costs have not yet bitten.

Factories supplied the one genuinely weak number. Industrial production held unchanged in August against a forecast gain of 0.4%, with the miss concentrated in manufacturing, which fell 0.3% and ended a seven-month run of increases. Motor vehicle assemblies fell more than 1% after seasonal adjustment, since the usual August rebound from summer retooling arrived smaller than in past years. The declines across primary metals, fabricated metals, computer and electronic products, aerospace and furniture read as the mirror image of July’s gains rather than a turn, and manufacturing output remains higher than a year ago, as it has for 15 consecutive months. Even so, the industrial production forecast loses a tenth this year and two tenths next year on higher rates and oil prices.

• Key Takeaway: A four-handle growth quarter built on restocking, equipment and wealth-supported spending is a real achievement and a temporary one, since two of those three legs run on cheap financing and calm supply chains. Record profit margins and an AI order book give the expansion more staying power than the headlines suggest.

Housing: Seven Percent Changes Everything

Mortgage rates have risen more than 30 basis points over the prior month and now approach 7%, which is the number that governs this entire section. Builders registered it immediately. The National Association of Home Builders (NAHB) index fell three points to 32 in September against a consensus of 34, with both current and expected sales deteriorating and respondents citing mortgage rates at their highest since May 2025, rising material costs and worsening labor shortages tied to stricter immigration policy. The backlog of completed homes for sale remains near levels last seen in mid-2009, and the share of builders cutting prices rose to 38% from 35% in August.

The construction data cut both ways in a single release. Housing starts fell 2.6% to a seasonally adjusted annual rate (SAAR) of 1.275 million, yet single-family starts rose 7.6% to 918,000, their strongest pace since March, while the volatile multifamily category sank 21.7% to 357,000. An upward revision of 70,000 to July leaves third quarter starts averaging 1.29 million, a shade under the 1.3 million estimate, with the residential investment tracker pointing to an annualized decline of about 3%. Permits, the steadier guide, slipped 2.7% to 1.39 million with declines in both categories, consistent with starts running flat to lower in coming quarters. Single-family momentum, in other words, looks like a good month rather than a turn.

Sales data were better than expected and matter less than they appear. Pending home sales edged up 0.3% in August against an estimate of a 2% decline, which points to roughly flat existing sales in September, though the forecast of about 4 million sales over the balance of the year now carries an expected markdown in October, reflecting a higher oil price profile and a second-rate increase in December. New home sales rose 6.4% to 684,000, the fastest pace of 2026, with July revised up 40,000 to 643,000, and yet the nowcast for real private residential investment still sits at negative 2.82% for the quarter.

Prices tell the affordability story without editorializing. The median new home price rose 0.4% to $393,700 in August while the annual change pushed further into negative territory at 5.8%, as the mix keeps shifting down-market. Homes priced above $600,000 have fallen to 18.7% of sales and now sit below the 20.3% share taken by homes under $300,000. When the expensive tier and the cheap tier trade places, the market is not cooling so much as reorganizing itself around who can still qualify for a loan.

• Key Takeaway: Every encouraging housing number this period arrived attached to a forecast downgrade, because rates near 7% overwhelm whatever the monthly data happen to say. Builders are discounting into a 2009-sized inventory overhang, and the sales mix is migrating toward the only buyers for which the math still works.

The Consumer, the Ballot and the Ledger

Households are spending well and feeling terrible, and the gap between those two facts keeps widening. The University of Michigan sentiment index fell to 48.1 in September from 51.7, with the damage concentrated in expectations, which plunged 10% for their largest decline since April 2025. Year-ahead inflation expectations jumped six tenths to 4.6%, their largest monthly gain in nearly six months, exceeding the 3.4% level that prevailed before the war began and fully reversing the summer’s improvement, while long-run expectations ticked up a tenth to 3.4% after three months unchanged. Headline PCE inflation now looks set to approach 4% by year end.

The spending that keeps holding up comes from a narrow place. Rising financial wealth reached a record share of household incomes in the second quarter, nearly double the share at the peak of the dot-com bubble, and most of it belongs to the top fifth of households by income, who are offsetting weakness elsewhere. Census data made the same point from the other direction: real median household income reached a record in 2025, but the top of the distribution logged a third consecutive annual increase while the bottom barely moved, and energy shocks are regressive because lower-income households spend a larger share of income on fuel.
The labor market, for its part, has gone quiet in the most reassuring way available. Initial claims fell 10,000 to 196,000 in the week ended September 12, with the four-week average at 203,250 and unadjusted claims running 22% below year-ago levels, though Labor Day timing flattered the figure, and continued claims dropped 39,000 to 1.73 million. The following week confirmed the message rather than reversing it, with initial claims down another 1,000 to 197,000 and the four-week average at 202,250. One state runs against the trend, as Hawaii saw claims rise after a category 5 hurricane, with El Nino supercharging Pacific storms. There is also a structural comfort here: research from the Boston Fed indicates the job market is far less vulnerable to energy price shocks than in prior decades. This is partly because the United States has been a net petroleum exporter since 2019, so oil-patch hiring offsets losses in importing states.

Politics and the ledger now sit closer to the macro-outlook than usual. Polling averages suggest Democrats lead in enough of the nine toss-up Senate races to take the chamber, with Texas the likely tipping-point contest, and they are expanding their generic-ballot advantage for the House. The fiscal consequences run through long yields. The baseline assumes a divided government accomplishes little beyond permanently extending the expiring tax provisions of the One Big Beautiful Bill Act (OBBBA), while upside scenarios would add one to three points to the federal debt-to-GDP ratio by fiscal 2035, and each additional point of public debt associates with a four basis point rise in the nominal 10-year Treasury yield. The war carries its own invoice, with the Congressional Budget Office (CBO) estimating that military operations in the region have cost the Pentagon about $38 billion, or 5% of its fiscal 2026 budget.

• Key Takeaway: The consumer who owns assets is carrying aggregate spending while the consumer who buys diesel is answering surveys at levels normally associated with recessions. An inflation expectation figure at 4.6% is the number that should worry the Fed most, because it is the one input a supply shock can turn into a demand problem.

Final Thoughts

The question left open two weeks ago closed the market’s way. The Fed hiked unanimously, and it hiked for a reason that has nothing to do with the textbook, namely that a damaged pipeline made the inflation outlook worse faster than any forecaster could revise it. Everything downstream followed: oil toward $110, diesel at levels implying $156 crude, inflation expectations at 4.6%, mortgage rates near 7% and a second hike now penciled in for December.

At the same time, the economy chose this moment to post its best quarter of the year, tracking just under 4% annualized on restocking, equipment spending and the households wealthy enough to ignore the price of fuel. Growth and comfort have come apart, and a central bank that now watches shipping lanes as closely as it watches wage data is the institutional acknowledgment of that. The September jobs report and the annual national accounts revisions land in the days ahead, but the variable that decides the next few months is unlikely to appear on any economic calendar.

Oxford Financial Group, Ltd. is a SEC-registered investment adviser. Registration does not imply a certain level of skill or training. The information provided is for general informational purposes only and should not be considered investment, tax, or legal advice. Opinions are those of the author and are subject to change based on market, regulatory or economic conditions. Forward-looking statements are opinions and/or estimates and are not guarantees of future results. Data and opinions are based on sources believed to be reliable, including unaffiliated third parties such as Oxford Economics, but their accuracy cannot be guaranteed. Past performance is not indicative of future results. See important disclosures and disclaimers at https://ofgltd.com/home/disclaimers. OFG-2609-63

The last letter closed on a wager: a chair who had tightened by talking had bought himself time, and the September data would show what he bought it for. The data have now arrived, and they cut in opposite directions, with a hot core consumer price reading on one side and a labor market that has quietly stopped being the problem on the other. Markets responded by pricing a rate hike at this week’s meeting.

Executive Summary

• Core Consumer Price Index (CPI) inflation surprised to the upside in August at 0.3% month over month, with headline CPI up 0.4%, though the same source data translate into a more benign 0.2% gain in the core Personal Consumption Expenditures (PCE) index that the Federal Reserve actually targets.
• Financial markets now price a rate hike at the September 15-16 meeting almost in full, plus a further 25 basis points before year end, while some forecasters, including Oxford Economics, call for the Federal Open Market Committee (FOMC) to stay on hold.
• Nonfarm payrolls rose 162,000 in August against a consensus of 55,000, July’s reported decline flipped to a 21,000 gain and the three-month average climbed to 71,000 from 38,000, comfortably around the 50,000 breakeven pace.
• Wage growth kept cooling, with average hourly earnings growth easing to 3.1% year over year and the Oxford Economics wage tracker below 3% for the first time in five years.
• The Beige Book showed activity improving in 10 of 12 districts with no district contracting for a second consecutive report, even as employment rose only very slightly and five districts reported no change at all.
• The nowcast for third-quarter growth now runs at a 3.5% annualized rate, helped by a 1.1 percentage point contribution from equipment spending that largely offsets a trade drag of more than a point.
• Consumer sentiment dropped to 47.8 in early September from 51.7, and short-run inflation expectations jumped to 4.6% from 4.0% as gasoline climbed.

The Fed: A Decision on a Knife’s Edge

The FOMC meets on September 15 and 16 with less consensus around the outcome than at any meeting this year. Following the stickier August CPI report, financial markets have moved to price a hike almost in full, along with another quarter point before the end of the year. The rate decision may not even prove the most informative part of the meeting, since the updated projections and Chair Kevin Warsh’s press briefing will say more about where policy goes next, and internal research now suggests the neutral policy rate has risen since the start of the year.

Governor Christopher Waller supplied the clearest map of how a committee member might vote, departing from the chair’s reserved tone to make plain that this is a live meeting: continued progress toward 2% would let him support holding, while inflation coming in hot would have him consider a hike. August obliged with something in between, which is precisely why the meeting sits on a knife’s edge. Markets had already leaned hawkish after the strong August payroll report, penciling in two full hikes by March 2027.

The case for patience rests on a technical point that deserves more attention than it usually gets. Nonmarket services prices, primarily financial services and insurance, accounted for roughly half the increase in core PCE prices in the prior month’s report, and those prices are imputed rather than observed, which means they move for reasons that have little to do with what anything costs. A Bureau of Economic Analysis methodology change due at the end of September should lower annual core PCE inflation by two tenths of a percentage point, with the treatment of stock-trading fees doing much of the work, and this combination could be the support the Fed needs for a protracted hold through the rest of this year and into 2027. Measuring inflation partly by imputing what people would have paid for services nobody billed them for is a reasonable way to build a price index and a difficult way to set an interest rate.

The Beige Book pointed the same direction. The in-house prices index fell for a second consecutive report, consistent with the recent run of moderate inflation readings extending into August, even as a growing number of Federal Reserve officials appear to be running short of patience with inflation that keeps sitting above target. Energy remains the live risk on the other side, since global oil prices surged after United States military strikes on Iranian targets revived fears of supply disruption, and gasoline prices will likely stay elevated without a meaningful end to the war. President Donald Trump’s announcement of access to 65 billion barrels of Venezuelan oil reserves offers no near-term relief, since that figure describes reserves in the ground rather than shippable supply, and Venezuelan production runs at about 7% of United States capacity.

• Key Takeaway: This is the closest call the committee has faced all year, and the gap between what markets price and what some forecasts assume has rarely been wider. The resolution turns on whether the Fed reads the hot consumer price print or the tamer reading from its own preferred gauge, and a methodology change at the end of September may quietly settle the argument either way.

Inflation: One Gauge Runs Hot, the Other Does Not

August core CPI rose 0.3%, above both estimates and consensus, while headline CPI rose 0.4% as gasoline perked up. The trouble sat in non-housing core services, the category the Fed watches most closely because it reflects domestic demand, where airfares, motor vehicle maintenance and repair, lodging away from home and wireless telephone services all accelerated. Transportation services carry a particular warning, since they suggest energy costs are working their way into a broader set of consumer prices, a risk the central bank will watch closely as the Middle East situation could worsen ahead of the midterms.

Nearly everything underneath offered reassurance. Core goods prices decelerated, with weakness in apparel, some recreational goods and motor vehicle parts, while computer software and accessories declined outright, a detail that matters because those artificial intelligence (AI) related prices carry outsized weight in the PCE measure; tariff effects are adding roughly three tenths of a point to core CPI inflation and should fade from here. Housing came in as expected, and a jobless expansion paired with a rising rental vacancy rate should prevent any reacceleration in the single largest CPI category. Small businesses corroborated the calm, since actual and planned selling price increases held unchanged in August despite the run-up in diesel.

Producer prices told the energy half of the story plainly. The August Producer Price Index (PPI) rose 0.4% with core prices up 0.3%, lifting annual headline producer inflation to 5.4% from 4.8% and core to 4.6%. Energy did the lifting at 4.2% on the month, and another increase looks likely in September, with diesel up nearly 60 cents and gasoline close to 20 cents within the survey window. The passthrough already shows in transportation and warehousing costs, up 2.3% for their largest monthly rise since April. Food prices rose a benign 0.1%, though diesel feeds grocery costs with a lag of up to nine months, so the reprieve looks temporary.

Put the two reports together and the Fed’s own gauge looks considerably calmer than the headline that moved the market. Mapping the CPI and PPI details points to a 0.37% rise in headline PCE prices and a more modest 0.19% increase in the core, a path that would nudge annual headline PCE inflation down to 3.6% from 3.7% while the core holds at 3.3%. Two thermometers hang in the same room, and this month they disagree by enough to decide an interest rate.

• Key Takeaway: Core consumer prices ran hot in exactly one place, non-housing core services, and that place carries the fingerprint of energy rather than of broad domestic overheating. The Fed’s preferred measure looks tamer, so the September decision may come down to which instrument the committee trusts.

The Labor Market: Solid Enough to Leave the Stage

The August employment report beat everyone. Nonfarm payrolls rose 162,000 against a consensus of 55,000, July’s reported 23,000 decline turned into a 21,000 gain, June moved higher too and the three-month average of job growth climbed to 71,000 from 38,000, still in the neighborhood of the roughly 50,000 breakeven pace. A 40,000 rebound in state and local government employment supplied much of the lift, exactly the payback that the July collapse implied, while manufacturing appears to have turned a corner and job losses in information and financial activities may carry an AI fingerprint. The unemployment rate rose five hundredths to 4.14% unrounded, for the encouraging reason that the labor force and household employment both grew, with participation up two tenths to 62.6%, though the prime-age rate stayed flat.

One strong month does not make an overheating labor market, and the rest of the evidence describes something closer to stillness. Private payrolls in the Automatic Data Processing (ADP) report rose only 38,000 in August, with the three-month average cooling to 60,000 from 107,000 in June. The July Job Openings and Labor Turnover Survey (JOLTS) showed the hiring rate falling to 3.2% from 3.4% while the layoff rate ticked down to 1%, the familiar no-hire, no-fire arrangement. The quits rate slipped a tenth to 1.9%, which is what happens when workers doubt they could find something better. Openings edged up 89,000 to 7.27 million even as June saw a 177,000 downward revision, leaving the ratio of openings to unemployed workers above one and the market roughly in balance.

Layoffs stayed conspicuously absent. Initial claims ticked up 2,000 to 206,000 in the week ended August 29, with announced job cuts from Challenger, Gray and Christmas the lowest for any August since 2022, then eased 1,000 to 206,000 in the week ended September 5, matching a four-week average at the same level. Unadjusted claims now run nearly 14% below year-ago levels, and continued claims fell to 1.774 million, some 7% lower than a year ago. Small firms echoed the reading, with hiring intentions dipping in August only after July had carried them to their highest level in nearly four years.

Wages are the part that matters for policy, and they keep cooling. Average hourly earnings rose 0.3% on the month while annual growth eased to 3.1% from 3.2%, and the broader Oxford Economics wage tracker fell below 3% for the first time in five years. The ADP measure for all workers slipped a tenth to 3.2%, and the only series still trending up covers job changers, a group whose ranks the low quits rate keeps thin. Set 3% wage growth against productivity running above 2% and the arithmetic points down rather than up.

• Key Takeaway: August was a strong month inside a stable trend, not the start of an overheating. Hiring stays slow, firing stays rare, and wage growth below 3% against productivity above 2% means the labor market has handed the inflation argument back to energy prices and imputed services.

Growth, Trade and the Ledger

The expansion keeps running on productivity rather than payrolls. The Beige Book found activity improving in 10 of 12 districts in the six weeks to August 24, with the in-house activity index easing to 0.74 from 0.80 and no district reporting contraction for a second consecutive report —the longest such streak since mid-2024. Employment, by contrast, rose only very slightly: five districts reported no change, and AI turned up more often in the commentary, boosting efficiency while cutting both ways on hiring, with some districts seeking AI engineers and contacts in Cleveland, Richmond and New York rethinking entry-level and administrative roles. Where wages did rise meaningfully, they rose in construction and manufacturing, the trades the AI buildout actually employs.

The productivity data supply the mechanism. Second-quarter productivity growth held at 1.4% for an annual pace of 2.2%, with manufacturing contributing heavily as a 5.4% rise in output met a 2.9% increase in hours. The more interesting detail sat in the non-financial corporate sector, where capital and technology spending concentrates: productivity there grew 2.2% and has run ahead of the nonfarm business measure since the second quarter of 2025, which may offer an early read on gains spreading to the rest of the economy as adoption widens. Unit labor costs, revised down a tenth to 1.2% annualized, confirm that none of this is coming out of a wage spiral.

Both purchasing manager surveys pointed to steady growth with the same lagging component. The Institute for Supply Management (ISM) manufacturing index eased a point to 54.6 while new orders and order backlogs held well inside expansion and customer inventories stayed in territory that signals firms need to restock. Its employment index slipped 1.6 points to 51.2 yet managed two consecutive months of expansion for the first time since 2022. The services index rose 1.3 points to 55.4, its strongest since February, and a weighted average of the two points to growth above 2% annualized in the third quarter, though the services employment index remained in contraction. Prices went the wrong way on both: manufacturing input costs held at an elevated 71.1 after a post-war peak of 84.6, and the services prices index jumped 2.3 points to 72.6, its highest since August 2022, with respondents naming the Middle East conflict and tariffs.

Trade delivered the paradox this letter keeps returning to. The July deficit widened to $88.6 billion from $73.3 billion, the largest since March 2025, as imports rose 2.8% against a 2.1% fall in exports, and the strength in imports sat entirely in capital goods, where a $14.4 billion rise left the category a staggering 46% above year-ago levels on computers, computer accessories and semiconductors. Net trade looks set to subtract more than a point from third-quarter growth, almost exactly offset by a 1.1-point contribution from the equipment spending those same imports represent. Construction told a two-sided story as well, falling 0.5% in July and dragging the residential investment nowcast to a 3% annualized decline from 1.6%, while business structures improved to a 1.5% decline from 4.1% as data-center construction kept running and power structures picked up. Add it together and the third-quarter growth nowcast now tracks 3.5% annualized. The ledger, as ever, quietly worsens. Treasury reported a $167 billion August deficit against $345 billion a year earlier, an improvement that is entirely a calendar fiction, since the August gap would have come in $9 billion wider on comparable terms. The fiscal year-to-date shortfall of $1.966 trillion sits $7 billion below last year, yet absent the same quirks it would stand $81 billion higher. Corporate receipts have fallen 24.3% under the One Big Beautiful Bill Act, customs receipts managed a 1.3% annual gain and roughly $40 billion of an anticipated $160 billion in tariff refunds has yet to go out the door. Against that backdrop, the President floated $5,000 checks for all adult citizens should Republicans hold both chambers after the midterms, a program costing as much as $1.25 trillion, or 3.8% of gross domestic product (GDP), and exceeding what Treasury will spend this year on defense, Medicare or interest. There is a very low probability the trifecta would allow it.

• Key Takeaway: Growth is tracking well north of 3% on productivity, equipment spending and a restocking cycle, with jobs contributing almost nothing to the total. The pattern is durable while it lasts, and the fiscal arithmetic keeps deteriorating underneath it in a way no single quarter makes urgent.

The Consumer and Housing: Wealth Holds, Mood Breaks

Consumers are spending like one group and answering surveys like another. The preliminary September reading of the University of Michigan sentiment index fell to 47.8 from 51.7, below the 51.4 forecast, with the assessment of current conditions falling and the view of the year ahead falling harder. Short-run inflation expectations jumped to 4.6% from 4.0% as gasoline climbed, and the long-run measure ticked up a tenth to 3.4%. The split by income keeps widening, since sentiment deteriorated among lower- and middle-income households while rising among upper-income ones, and economists anticipate that the upper tier will carry consumer spending growth of around 2% through the rest of the year.

The spending data are considerably more cheerful than the mood. Consumer credit rose $18.1 billion in July, with nonrevolving credit up $15.3 billion against a more modest $2.8 billion in revolving credit, whose annual growth slowed to 3.6% from 4.1% as the tax-refund tailwind faded. Excluding student loans, nonrevolving credit rose $10.2 billion, essentially an auto lending story. Student loans grew just $0.3 billion in the first month that the borrowing caps and stricter repayment rules under the One Big Beautiful Bill Act applied, and since borrowers need not switch to the new income-driven plan until 2028, the effect will show up only gradually.

Vehicles made the point in the plainest terms available. Sales jumped to a 16.8 million annualized pace in August, the strongest since April 2025 when buyers were front-running tariffs, leaving third-quarter sales tracking 1% above the second. Higher pump prices have tilted the mix toward hybrids, whose share peaked at 17.1% in May against 13.9% in February, and gasoline has averaged above $4 a gallon since mid-July. Fully electric and plug-in hybrids account for just 6.8% of sales after averaging above 9% in 2025. The top fifth of the income distribution buys more than half of all new vehicles by dollar value, which is why sales can boom while sentiment sinks, and the September baseline looks for 16 million sales this year against 16.2 million in 2025.

Housing remains where the cost of higher-for-longer shows up most plainly. Existing home sales fell 2% in August to 3.98 million, down 1.2% from a year earlier, adding downside risk to a forecast of residential investment declining at a 2.1% annualized pace. The more telling signal was inventory, which rose 3.2% on the month and 5.9% over the year, an unusual direction once the spring selling season has passed and a plausible sign that homes are sitting longer, leaving 4.9 months of supply at the August pace. The median price fell 1.7% on the month while holding a 1.6% annual gain, with the forecast still near 2% growth. The cause sits in the bond market rather than at the Fed: after briefly touching 6% before the war with Iran, mortgage rates now run near 6.75%, which has pushed the monthly payment on a median-priced home up nearly $300, or 15%.

• Key Takeaway: The consumer who owns assets keeps buying cars while the consumer who buys gasoline keeps answering surveys badly, and the aggregate numbers describe neither one accurately. Housing is the clearest casualty of long rates that higher oil prices, heavier public borrowing and a surge in corporate issuance have pushed up regardless of what the Fed decides this week.

Final Thoughts

The question left hanging two weeks ago has an answer, and the answer is that nobody agrees. Core consumer prices ran hot at 0.3%, the labor market delivered a 162,000-payroll gain that removed any excuse for worrying about jobs and markets promptly priced a hike this week plus another before year end. Against that, wage growth slipped below 3%, the Beige Book price index fell for a second straight report and the Fed’s own preferred gauge looks set to come in near two tenths for the core.

Growth, meanwhile, has quietly become the least controversial thing in the economy, tracking 3.5% annualized on productivity, equipment spending and a restocking cycle that owes almost nothing to hiring. That is a comfortable place for an expansion to sit and an uncomfortable place for a central bank, since an economy this strong offers little cover for patience if the next price print misbehaves. Wednesday settles one question and opens several more, and for once the interesting part of the meeting may be the projections rather than the decision.

Oxford Financial Group, Ltd. is a SEC-registered investment adviser. Registration does not imply a certain level of skill or training. The information provided is for general informational purposes only and should not be considered investment, tax, or legal advice. Opinions are those of the author and are subject to change based on market, regulatory or economic conditions. Forward-looking statements are opinions and/or estimates and are not guarantees of future results. Data and opinions are based on sources believed to be reliable, including unaffiliated third parties such as Oxford Economics, but their accuracy cannot be guaranteed. Past performance is not indicative of future results. See important disclosures and disclaimers at https://ofgltd.com/home/disclaimers. OFG-2609-21

The last letter left two questions hanging: what the July minutes would reveal about a committee that had argued its way to a hold, and whether the summer calm in inflation would survive contact with rising prices at the pump. Both found answers, and the more consequential one arrived from a podium in Wyoming rather than from any data release. Chair Kevin Warsh used his first Jackson Hole keynote to tell the market that policy is not restrictive, inflation is falling too slowly and the market obligingly delivered the tightening he declined to deliver himself.

Executive Summary

• Chair Warsh used his Jackson Hole keynote to reaffirm 2% Personal Consumption Expenditures (PCE) inflation as a firm, fixed target to argue that current policy settings are not restrictive, and to conclude that underlying inflation is not falling fast enough.
• Markets read the speech as a hawkish turn, shifting the September decision to a coin toss from roughly one-in-three odds of a hike and pricing two increases over the coming year.
• The preliminary benchmark revision trimmed March nonfarm payrolls by 79,000, which would lower average monthly job growth in the year through March to 16,000 from 23,000, a modest adjustment beside the 861,000 final revision for 2025.
• Second-quarter gross domestic product (GDP) growth held at 1.5% annualized, with an upward revision to consumption offset by weaker net exports, while corporate profit margins reached a record high. According to Haver Analytics, Core PCE inflation is forecasted to finish the year near 3.2% before easing to 2.3% by December 2027.
• The University of Michigan consumer sentiment index fell to 51.7 in August from 55.2, with the steepest decline among Republican respondents, while the Conference Board measure slipped to 89.4 from 90.2 on the weakest expectations reading since January.
• Housing stayed in its rut, with starts down 12.4% in July even as permits rose 5%, and new home sales down 10.5% with mortgage rates at 6.65%.
• The advance goods trade deficit widened $17.4 billion to $118.8 billion, its largest since the first quarter of 2025, on an 11.3% surge in capital goods imports tied to the artificial intelligence (AI) buildout.

Jackson Hole: The Speech Was the Tightening
Mountain air apparently agrees with Chair Warsh. In a wide-ranging keynote he delivered the clearest account of his monetary policy views since taking the job with what appeared to be three hawkish shifts inside it. First, after months of studied ambiguity, he reaffirmed that 2% inflation on the PCE measure is a firm, fixed target. Second, he implied that policy settings are not restrictive, a departure from the slightly restrictive language of former Chair Jerome Powell and from a dot plot in which most members place the policy rate above their longer-run neutral level. His evidence was the strength of business capital spending, profits, low corporate credit spreads and looser borrowing conditions, housing weakness notwithstanding. Third, he argued that underlying inflation is moderating too slowly, and that the summer readings did not show meaningful improvement.

His preferred evidence was breadth rather than level. Roughly half the PCE basket is now rising by more than 3% a year, a share that keeps falling but still sits above the 32% average of the two decades before the pandemic. Markets took the point. The September decision moved to a coin toss from roughly one-in-three odds of an increase, and futures now carry two hikes over the coming year, well away from the prior baseline of an extended hold. A chair who dislikes forward guidance managed to move the rate path a good deal further with one speech than most of his predecessors managed with a statement.

It is worth noting that experts can read that same breadth differently. Much of it could very well reflect temporary supply shocks working through goods prices, tariff inflation continues to fade and AI-related inflation should look smaller once the September methodology changes land, which leaves energy passthrough as the genuine wild card; in services, where the persistent inflation actually lives, breadth is normalizing more quickly as productivity gains meet slowing wage growth. The two views also part company on jobs. Warsh played down the other half of the mandate, treating softer payroll growth as a labor supply story and lower openings and quits as evidence of better matching after the pandemic, a reading more sanguine than the view that labor demand remains fragile.

What the speech left out matters nearly as much as what it contained. There was no mention of balance sheet policy, despite hints in the July minutes that the committee is preparing to take it up, and none of Treasury Secretary Scott Bessent’s move to buy back more longer-dated debt, which could work at cross purposes with monetary policy. Forward guidance stays buried and a chair who speaks less often raises the odds that markets overreact to any single word he does use, which may be the point. Financial conditions have tightened over the past few months without a single change in the policy rate, giving the hawks the restraint they want while preserving the flexibility the doves prefer. It is the monetary policy equivalent of a conductor lowering the baton and letting the orchestra play louder on its own.

The plumbing beneath the speech moved as well. The July minutes showed participants expecting inflation to step down over coming months while waiting for more clarity, and policymakers have been weighing a cut in regular meetings from eight a year to six starting next year. On the Treasury side, the at-least doubling of the cap on buybacks of longer-dated securities signals discomfort with the recent rise in yields, though the sums stay small: lifting the cap to $4 billion from $2 billion implies roughly $28 billion of purchases between September and November against a prior cap of $14 billion, a fraction of what the Fed bought in any round of quantitative easing, and the Treasury must borrow elsewhere to pay for it. Oxford Economics does not expect such measures to offset rising corporate issuance, persistent federal deficits and the threat of further supply-shock inflation, all of which push long yields the other way. One threat did come off the board: the administration postponed the 50% Section 338 tariffs on Canada shortly before their August 19 start date, sparing an increase in the effective rate on Canadian goods to 6.9% from 5.1% and a two-tenths addition to the overall effective rate.

• Key Takeaway: Warsh moved the rate path without moving the rate, and markets now price two hikes. That gap is the single most important variable heading into September, and it is projected to close on the inflation data rather than on anything further the chair chooses to say.

The Labor Market: A Smaller Number, the Same Story
The annual benchmark revision arrived, and for once it did not detonate. The Bureau of Labor Statistics (BLS) put its preliminary revision to March nonfarm payrolls at negative 79,000, which would lower average monthly job growth in the twelve months through March to 16,000 from 23,000. Set that beside the final revisions of negative 861,000 for 2025 and negative 598,000 for 2024 and the number looks almost polite. The estimate rests on the Quarterly Census of Employment and Wages (QCEW), a fuller count drawn from unemployment insurance records, and it came as a mild surprise, since the QCEW data through December had pointed the other way.

The private sector cut ran deeper at 178,000, though that amounts to roughly 0.1% of employment against a 0.2% average absolute revision over the past decade, and it implies average monthly private job growth of 27,000 in the year to March. Two caveats keep this from meaning much. The revisions look backward, and the preliminary figure is rarely the last word: in nine of the past ten years the final revision has landed more positive than the preliminary estimate, by an average of 71,000. Information, transportation and utilities saw the largest upward adjustments, while wholesale trade, mining and retail took the largest cuts and federal employment fell sharply over the benchmark period on layoffs and resignations.

The weekly data kept describing a market that hires reluctantly and fires almost never. Initial claims fell 6,000 to 206,000 in the week ended August 15, with no visible lift from the wildfires in the Northwest, then eased again to 203,000 the following week, running 11.2% below year-ago levels on an unadjusted basis. Continued claims kept up their usual see-saw, rising to 1.799 million in the week ended August 1 with the four-week average steady at 1.790 million and 8% below the prior year, then falling 18,000 to 1.778 million in the week ended August 15. Demand for workers stays soft, but the supply of workers has softened faster, which is why the balance holds.

Households noticed. The Conference Board differential between those calling jobs plentiful and those calling them hard to get jumped 4.8 points to 7.5%, a reading that taken on its own would imply an unemployment rate near 4.8%, though Oxford Economics looks instead for a rate holding near 4.2% as slower labor force growth and reduced net immigration keep the arithmetic in balance. The gap between what the differential implies and what the forecast says is a reminder that perception surveys measure mood as much as they measure hiring.

• Key Takeaway: A benchmark revision of 79,000 changes the labor market story by almost nothing, and history suggests the final number will come in friendlier still. Claims near 200,000, continued claims below year-ago levels, and improving perceptions all point to the same balanced market that has let the Fed keep its attention on prices.

The Consumer: Steady Wallet, Sour Mood
The second reading on second-quarter growth left the headline alone and improved the contents. Real GDP still grew 1.5% annualized, but an upward revision to consumer spending offset a downward revision to net exports, and corporate profit margins advanced to a record high, which bodes well for business investment ahead. Real consumer spending then came in flat in July, with the weakness concentrated in goods, particularly recreational goods, motor vehicles and parts, and apparel, while services carried the month on recreation and transportation, two categories that respond keenly to household wealth.

The tracking numbers hold up better than the July print suggests. The Oxford Economics nowcast for third-quarter consumption points to a 2% annualized gain, an improvement on the estimate that followed the weak retail sales report, helped by favorable revisions to prior months and by personal income rising more than anticipated on dividends, government social benefits and above all private wages and salaries. The price side is where the comfort runs out. Both headline and core PCE indexes came in a touch firmer for the second quarter. Headline PCE inflation is likely to hover above 3% through the second half on the energy shock and the AI buildout.

The mood, meanwhile, curdled. The University of Michigan sentiment index fell to 51.7 in August from 55.2, reversing much of July’s improvement, and the decline reached across the political spectrum, with sentiment among Republican respondents off more than 7% to its lowest level for that group since the 2024 election. The Conference Board told a similar story from a different angle, slipping to 89.4 from a downwardly revised 90.2 as expectations for income, business conditions and the labor market six months out sank to their weakest since January. Inflation expectations gave a mixed reading. The Conference Board year-ahead measure rose two tenths to 5.8% in line with renewed pressure at the pump, while the Michigan short-run measure eased three tenths to a still-high 4.0% against 3.4% before the war began, with the long-run figure steady at 3.3%.

Underneath the averages, the split that has defined this year grew sharper again. Sentiment fell among low- and middle-income consumers and rose among high-income respondents, since elevated gasoline prices fall hardest on households that spend the largest share of income on essentials, while strength in equity markets keeps lifting the top end through the wealth effect. The personal saving rate has slipped below 3%, down from an average of 4.6% in 2025, and rebuilding that cushion will hold back spending at the lower end even as energy prices eventually ease. The link between how consumers feel and what they spend has frayed considerably in recent years, which is fortunate, because the feelings look worse than the receipts.

• Key Takeaway: Spending is holding up better than sentiment, margins hit a record and income growth keeps doing the quiet work. The catch is that core inflation is now projected to end the year above 3%, which may hand the hawks their argument and leave the lower-income consumer absorbing the difference.

Industry and Trade: The Buildout Spreads, and So Does the Bill
Factories kept broadening out. Industrial production rose 0.2% in July, a shade under expectations, though a revision lifted June to 0.3% from an initially published 0.1%. AI-linked industries still supply the horsepower, with computer and electronic products posting another solid gain, and the spillovers now reach electrical equipment, machinery and metals, all of which advanced in July. Federal money is lifting defense and space equipment, including drones, missiles and satellites, while aerospace lurched ahead as regulators cleared Boeing to hit new production milestones after years of setbacks. Factory output would have looked stronger still without a drop in motor vehicle production, which typically plunges in July on summer retooling. The baseline still calls for industrial production to grow 1.3% this year, with a turn in the inventory cycle spreading the gains beyond the AI-linked industries.

Orders told the same story with a softer voice. Headline durable goods orders rose 1.1% in July, ex-transportation orders gained 0.4% and nondefense capital goods orders excluding aircraft, the cleanest read on capital spending intentions, managed only 0.2% against a forecast of 0.5%, though a revision took the June figure up to 1.7% from 1.2%. Orders for computers and electronic products slipped 1.1% after a strong June and still stand 14.8% above a year ago, with machinery and metals both growing at double-digit annual rates. The August baseline assumes business equipment spending grows 6.8% annualized in the third quarter, a sharp step down from 15.2% in the second but a solid pace all the same.

The same buildout that flatters the factory data punishes the trade data. The advance goods deficit widened $17.4 billion to $118.8 billion in July, the largest since the first quarter of 2025, as imports climbed 3.7% while exports fell 2.9%. The entire import gain traced to an 11.3% jump in capital goods, essentially computers, computer accessories and semiconductors, while every other import category fell 1.6%. On the export side, industrial supplies fell $9.0 billion on weaker petroleum shipments, though oil exports perked back up in August. Net trade looks set to subtract more than a percentage point from third-quarter growth, with the risks tilted toward a larger drag. The pattern has become familiar enough to name: the country buys the hardware abroad, books the spending at home and watches the two largely cancel in the growth arithmetic.

Import prices offered the clearest piece of relief. They fell 0.4% in July, with a 7.2% drop in fuel prices accounting for the entire decline, while nonfuel prices rose 0.4%, a slowdown from the 0.6% average monthly gains of the first half, leaving the annual increase at an elevated 5.9%. Oxford Economics looks for global oil to bounce around $80 a barrel until a durable peace between the United States and Iran takes hold. The wildcard sits where it always sits now, in computers and electronic accessories, whose prices have climbed an average of 2.1% a month through July.

• Key Takeaway: Manufacturing is no longer a one-industry story, with defense, aerospace, machinery and metals joining the AI complex, and profit margins at a record support the case that capital spending has further to run. The bill arrives in the trade account, where a widening deficit will keep subtracting from measured growth.

Housing: Still in the Rut
Housing is demonstrating what higher-for-longer actually costs. Starts fell 12.4% in July to a seasonally adjusted annual rate (SAAR) of 1.239 million, well under the 1.325 million estimate and the 1.345 million consensus, with single-family starts down 9.9% and multifamily down 16.8% after a 77% spike in June. Permits, the steadier guide, went the other way, rising 5% to 1.443 million against expectations of 1.375 million, with single-family permits up 2.5% to their best level since March. Even so, the residential investment tracker now points to a 2% annualized decline this quarter against the 0.1% dip in the baseline.

Builders remain unimpressed. The National Association of Home Builders (NAHB) index ticked up a point to 35 in August, above the 33 consensus but still the sixteenth consecutive month below 40, the longest such streak since the 2011-2012 foreclosure crisis, and keeping the pressure on is mortgage rates at their highest since last August. The obstacle is the overhang: the supply of unsold completed homes has come off its highs from earlier this year but still sits near levels last seen in mid-2009. Builders keep buying their way out of it, with the share offering price cuts easing to 35% in August from 37% in July while incentives eat into margins.

Sales data pointed the same direction. Pending home sales fell 2.3% in July, worse than the 1% decline forecast and the flat consensus, alongside a 6.5% drop in mortgage purchase applications and mortgage rates at their highest since August 2025. Because contracts lead closings by roughly thirty days, that points to another dip in existing home sales in August, with the forecast holding existing sales just above 4 million through the rest of the year. New home sales fell 10.5% to 607,000, though a hefty upward revision took June to 678,000 from 628,000, which suggests July overstates the weakness; mortgage rates stood at 6.65% as of August 20, and the supply of new homes at 488,000 works out to 9.6 months at the July selling pace. The median new home price fell 2.3% to $393,800, keeping the annual change negative, as homes above $600,000 slipped to 19.7% of sales on a trend basis, their smallest share since September 2021.

Prices, for all that, refuse to break. The S&P Cotality Case-Shiller national index rose 0.1% in June and 1.5% over the year, with annual changes across the twenty-city index running from a 1.9% decline in Seattle to a 6.9% gain in Chicago. The Federal Housing Finance Agency (FHFA) index was flat on the month and up 2.3% over the year, easing from 2.4% in May, with all nine Census divisions positive, from 0.4% in the Pacific to 4.9% in the East North Central. A market where almost nobody wants to buy and almost nobody has to sell does not crash. It simply stops moving.

• Key Takeaway: Starts fell hard, permits rose and the truth sits between them: construction moving sideways while builders work off inventory near 2009 levels. Prices hold up because supply stays lean, which makes housing the clearest illustration of what a Fed on hold at these rates costs the real economy.

Final Thoughts
Two weeks that looked quiet on the calendar delivered the most consequential Fed communication of the year. Warsh told Jackson Hole that 2% remains a firm, fixed target, that policy is not restrictive, and that inflation is easing too slowly, and the market answered by moving September to a coin toss and pricing two hikes over the coming year. Underneath the speech the economy behaved much as it has all summer. The benchmark revision took 79,000 jobs off the March level and changed nothing that matters, claims stayed near 200,000, spending held up while sentiment sagged and manufacturing kept broadening beyond the AI complex.

The complication is the one the chair named. Core inflation is forecasted to end the year above 3% rather than drifting quietly toward target. Housing is paying the price of rates that have not come down, and the lower-income consumer is absorbing a gasoline bill the wealthier half barely notices. A chair who tightens by talking has bought himself time, and the coming round of jobs and inflation data will show why he bought it. For now, the economy keeps doing what it has managed all year, growing through the noise while the argument over rates carries on above it.

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