Growth cools, but inflation keeps markets on edge

Summary

Last week in markets

U.S. equities finished higher despite a volatile week. The S&P 500 Total Return Index gained 1.06% from Monday through Friday, supported by a strong finish to the week and solid earnings from Amazon. Apple’s weaker outlook, however, reinforced the growing performance gap among large-cap technology companies.

The Federal Reserve left the federal funds rate unchanged at 3.50% to 3.75%. Still, three officials dissented in favor of a 25 basis point (bp) increase, signaling greater concern about persistent inflation. That division underscores the Fed's willingness to keep policy restrictive if price pressures fail to ease and leaves markets increasingly sensitive to upcoming inflation data.

Treasury yields moved higher as the week progressed. The 10-year Treasury yield ended Friday at 4.75%, up 10 bps from Monday, even as second-quarter GDP slowed to an annualized 1.5%. While headline growth moderated, underlying private-sector demand remained resilient. June headline and core PCE inflation measured 3.7% and 3.3% year over year, reinforcing the challenge policymakers are facing as they balance slowing growth against inflation that remains above target.

Energy markets reflected heightened geopolitical uncertainty. Front-month Brent crude settled at $90.12 per barrel after a volatile week. Prices fell early on expectations of renewed U.S.-Iran diplomacy before surging nearly 8% as hostilities resumed. Even so, Brent finished the week down 6.88%, illustrating how quickly geopolitical developments continue to reshape inflation expectations.

The week ahead

This week's economic calendar will help determine whether signs of slower growth are becoming more widespread or whether inflation risks continue to dominate the outlook.

The week begins with July ISM manufacturing data on Monday, followed by June job openings and factory orders on Tuesday and July ISM services on Wednesday. The Federal Reserve's Senior Loan Officer Opinion Survey, also released Monday, will provide important insight into credit conditions. Together, these reports will show whether labor demand is easing, businesses are pulling back, and banks are tightening lending standards. Markets will look beyond headline activity, paying close attention to employment trends and prices paid. Evidence of persistent services inflation or renewed input cost pressures could place additional upward pressure on Treasury yields.

Labor market data will remain the primary focus during the second half of the week. ADP employment is scheduled for Wednesday, followed by second-quarter productivity and unit labor costs on Thursday and the July employment report on Friday. Consensus expectations call for payroll growth of 88,000, an unemployment rate of 4.2%, and average hourly earnings to increase 0.3% from June.

A softer employment report accompanied by moderating wage growth would support the view that inflation pressures are gradually easing, reducing pressure on the Federal Reserve. Conversely, stronger hiring or firmer wage gains could reinforce expectations that policymakers may raise rates again as soon as September. Governor Lisa Cook's remarks on Wednesday may offer an early indication of how the Federal Reserve is interpreting the latest economic data.

Outside the economic calendar, energy markets remain the largest source of uncertainty. Investors will assess OPEC+'s decision on September production while continuing to monitor shipping activity through the Strait of Hormuz, security conditions in the Red Sea, and developments in U.S.-Iran relations. Greater supply or improved shipping conditions could help ease inflation expectations. Any renewed disruption to energy infrastructure or commercial shipping, however, would likely push crude prices and longer-term Treasury yields higher.

The central question for markets is whether cooling growth can continue without another energy shock hardening the Fed’s inflation response.