Last week’s letter left the Federal Reserve walking into a crosscurrent: a wall of data that argued for patience and a reopened energy shock that argued for vigilance. This week the wall arrived, and the Federal Open Market Committee (FOMC) chose patience, holding rates steady in a testy 9-to-3 vote while the economy underneath turned in a stronger performance than the headline growth number let on. The hawks got their say, the doves got their data and the rest of us got a reminder that a divided Fed can still sit remarkably still.

Executive Summary

• The FOMC voted 9 to 3 to hold its policy rate at 3.5% to 3.75% in July, with three regional Federal Reserve presidents dissenting in favor of a hike. Markets had priced roughly a one-in-three chance of an increase, so Treasury yields fell sharply once the decision landed.
• Real gross domestic product (GDP) grew a subdued 1.5% annualized in the second quarter, below the 2% consensus, while artificial intelligence (AI)-related investment added just 0.4 percentage points on net to growth, roughly its first-quarter contribution.
• Core Personal Consumption Expenditures (PCE) inflation rose only 0.1% in June, a touch below the 0.2% expected and a benign reading for a Fed watching for tariff and AI passthrough.
• Initial jobless claims stood at 197,000 in the week ended July 25, just off the lowest level in nearly 60 years, and the Employment Cost Index (ECI) rose 0.9% in the second quarter for a 3.4% annual pace consistent with the 2% inflation goal.
• Consumer spending grew a resilient 3.2% annualized in the second quarter, even as the personal saving rate slipped to 2.7%, and gasoline climbed back above $4 a gallon after the Strait of Hormuz closed again, keeping upside risk on inflation alive.

The Fed: A Family Fight Ends on Hold

The Federal Reserve held its policy rate at 3.5% to 3.75% in July, and the vote told the more interesting story: 9 to 3, with three regional Federal Reserve presidents dissenting in favor of a hike. Dallas Fed President Lorie Logan and Cleveland Fed President Beth Hammack had each signaled a preference for hiking sooner, so their votes surprised no one, while Neel Kashkari’s dissent counted as the plot twist. Think of it as a family that argues loudly over dinner and then agrees, for now, to leave the thermostat where it is.

Financial markets had not made up their minds going in, pricing roughly a one-in-three chance of a hike, so the decision to stand pat sent Treasury yields down sharply in its wake. The statement itself changed little from the mid-June version, a sign that Chair Kevin Warsh remains content to let tighter financial conditions do some of the work rather than move the rate himself.

• Key Takeaway: The July hold was never really in doubt, but the 9-to-3 split, and three hawkish dissents reveal a committee that remains genuinely divided. With Chair Warsh leaning on financial conditions, the path of least resistance is no move at all, in either direction, for a good while.

Inflation and Wages: The Doves Find Some Cover

The data handed the committee’s patient majority a useful gift. Core PCE inflation, the gauge the Fed prefers, rose only 0.1% in June against expectations for 0.2%, showing little of the tariff or AI passthrough that has haunted the outlook. That is the kind of quiet number that lets a central bank sit on its hands with a clear conscience.

The relief comes with an asterisk. Core inflation still faces a trio of supply shocks: tariff feedthrough, tightness in AI-related product markets, and the fallout of the Iran war on oil and global supply chains. Oxford Economics expects core inflation to stay stubbornly above target and end the year near 3.1%, with headline PCE hovering above 3% in the second half as gasoline climbs back above $4 a gallon. Falling inflation is the destination, not yet the itinerary.

Wages, at least, are not the problem. The Employment Cost Index, the measure that controls for shifts in the mix of jobs, rose 0.9% in the second quarter, a hair above the 0.8% expected. At a 3.4% annual pace, with trend productivity growth north of 2%, that reading fits the 2% inflation target rather than threatening it, and a low quits rate points to the ECI holding between 3.3% and 3.4% into next year. The inflation that worries the Fed lives in goods and energy, not in the paycheck.

• Key Takeaway: June’s soft core PCE reading and a benign ECI give the doves cover to keep rates steady, since the labor market is not stoking inflation. The catch is energy: with the Strait of Hormuz shut again and gas back above $4, headline inflation will likely stay above 3% into year-end, keeping the hawks in the room.

Growth: Signs of Life Beyond AI

The headline growth number looked tired, but the details had more energy than the label suggested. Real GDP grew 1.5% annualized in the second quarter, short of the 2% consensus. The softness came from two sources that tend not to last: a widening drag from imports and a drawdown in inventories, both of which should reverse and push growth back above 2% in the second half.

Consumer spending did the heavy lifting, and it did more than expected. Real consumption grew 3.2% annualized in the quarter, a bounce from the weather-depressed first quarter helped along by an unusually generous tax refund season. Revisions to prior months lifted the trend as well, which suggests the underlying pace was firmer than the earlier data implied.

Then there is the artificial intelligence story, which keeps looming large and delivering less than its billing. Business investment posted another solid gain led by AI-driven equipment, but because most of that hardware comes from abroad, it drags imports up by a nearly equal amount. The net result: AI-related investment added just 0.4 percentage points to annualized growth, about the same modest contribution as in the first quarter. The more encouraging signal came from everywhere else. Investment outside AI posted its biggest quarterly gain in three years, a broadening that may build as tax incentives and lean inventories pull spending along.

• Key Takeaway: The 1.5% growth print undersells an economy still on its feet, with temporary trade and inventory drags masking resilient consumption and a genuine stirring of investment beyond AI. The Fed can keep its eyes on inflation precisely because growth is not the thing that gives it trouble.

Equipment Spending and the AI Import Paradox

If one corner of the economy is running hot, it is business equipment. Headline durable goods orders rose a modest 0.3% in June, restrained by the volatile transportation category, but the better gauge of underlying intentions, core capital goods orders excluding aircraft, gained a solid 0.9%. Shipments, which flow directly into GDP, rose 0.7%, and Oxford Economics now tracks business equipment investment growing at a breakneck 19% annualized pace in the second quarter, topping even the 15.8% gain of the first.

The momentum rests on more than one leg. Firms are rebuilding inventories they ran down ahead of tariffs, the AI buildout keeps orders for computers and electronics humming and spills into machinery and metals, and last year’s tax package raised the after-tax return on new equipment. The main risk to all of this is the on-again, off-again conflict with Iran, though so far uncertainty over oil prices has not deterred companies from spending.

The same equipment boom leaves its fingerprints on the trade data, and not flatteringly. The advance goods trade deficit actually narrowed in June, to $101.5 billion from $105.9 billion, as an 8.2% drop in imports outran a 3.8% fall in exports. The telling detail is capital goods imports, which fell $2.5 billion for their first monthly decline since September 2025, yet still sit 37% higher than a year ago on AI hardware demand. Because so much of the gear comes from abroad, the paradox holds: the AI spending that dominates the headlines has added next to nothing to GDP on a net basis. For the quarter, net trade shaped up as a drag of more than a full percentage point on growth.

• Key Takeaway: Business equipment investment is the standout of the quarter, sprinting near 20% annualized on restocking, the AI buildout and last year’s tax cuts. The irony endures: because the hardware behind the boom largely comes from abroad, it swells the trade deficit and leaves AI’s net contribution to measured growth surprisingly small.

The Consumer, Jobs, and Housing

The consumer is sending mixed signals, which is to say the consumer is behaving like a consumer. The Conference Board’s confidence index slipped to 90.8 in July from an upwardly revised 92.2, with households gloomier about business conditions, jobs and their own finances. Yet the University of Michigan’s sentiment index moved the other way, jumping to 55.2 from 49.5, a gain of nearly 12%. The two surveys rarely disagree this politely, and the split likely reflects timing around the swings in gas prices.

Behind the mood readings, the spending math is straining. The personal saving rate has fallen to 2.7%, well under the 4.6% average of 2025, a sign that households have leaned on savings to ride out the energy shock. Lower-income consumers saw only muted gains because they feel gasoline most acutely, while wealthier households, buoyed by tax refunds and rising markets, keep the aggregate afloat. The bifurcation that has run through this year is still very much with us.

The labor market, meanwhile, keeps quietly defying the gloom. Initial jobless claims rose a modest 9,000 to 197,000 in the week ended July 25, a small rebound from the lowest level in nearly 60 years. Continued claims fell to 1.782 million, the fewest since 2023, and with layoffs low tighter immigration and an aging population restraining labor-supply growth, the unemployment rate is likely to hold near 4.2% or possibly even edge lower. The Conference Board’s own labor differential, the gap between those calling jobs plentiful and those calling them hard to get, narrowed to 3.1 points from 3.8, a reminder that hiring has cooled even as firing stays rare.

Housing is holding its ground despite a stiffer headwind from mortgage rates. The S&P Cotality Case-Shiller national index was essentially flat in May but rose 1.1% from a year earlier, up from 0.9%, while the Federal Housing Finance Agency (FHFA) index gained 0.3% on the month and 2.2% over the year. That resilience holds even as mortgage rates have climbed to nearly 6.6%, their highest since August 2025, as markets price in a more hawkish Fed. Prices are likely to stay positive, with slowing supply growth keeping the market roughly in balance.

• Key Takeaway: The consumer looks stretched but stubborn, spending out of a saving rate down to 2.7% while the mood surveys pull in opposite directions. The labor market stays tight with claims near multidecade lows, and housing keeps grinding higher despite mortgage rates near 6.6%, leaving the Fed an economy sturdy enough to keep its focus on inflation.

Final Thoughts

The cliffhanger from last week resolved about as expected: the Federal Reserve held, the vote splintered 9 to 3 and the economy underneath the decision looked sturdier than the 1.5% growth headline let on. Core inflation cooled, wages stayed tame and jobless claims lingered near a 60-year low, the sort of combination that lets a central bank wait without looking negligent.

The complication is the one that has shadowed all year: energy. With the Strait of Hormuz closed again and gasoline back over $4, the disinflation the doves are counting on could stall, and the three dissenting hawks will not stay quiet if it does. For now, the economy is doing what it has managed all year, growing and spending through the noise. After a year of shocks, an economy that carries on while its central bank sits still is a version of calm worth appreciating, even if it proves temporary.

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