Where Is the Economy Now? — Q2 2026

Despite high energy prices, growth trends for the second quarter remain in good shape fed by the increasing AI buildout and a resilient consumer sector. Consumers tapped into their savings amid the run up in gasoline prices, but with lower oil and gas costs in the wake of the interim deal with Iran, consumers should get some needed inflation relief.

The economy continues to be solid and assuming the Strait of Hormuz reopens completely, lower energy and commodity prices should provide further support. Additionally, if the labor market remains healthy, that could ensure continued positive underpinnings for consumer spending.

Employment: Labor Market Momentum Builds

Hiring has strengthened over the past three months, with job gains topping expectations in May despite higher energy prices and concerns that AI adoption would reduce demand for workers. Growth was led by leisure and hospitality, local government and health care, while construction also posted firm gains.

Stronger hiring is helping to offset consumer headwinds by supporting household income. Low unemployment also suggests employers remain largely in a no-fire stance, which should limit pullback in consumer spending. Improved hiring supports an outlook of the Fed standing pat through the end of the year.

Inflation: Up Again Due to Energy Prices

Headline CPI accelerated to 4.2% in May, a three-year high, as another jump in gasoline prices accounted for most of the monthly increase. Core inflation rose a softer-than-expected 0.2%, with weakness in motor vehicle prices and insurance helping offset firmer rent and airfare increases.

With gasoline prices down in recent weeks, inflation has likely peaked and should cool in the second half of the year if the Strait of Hormuz reopens completely. That outlook should keep the Fed on hold until 2027.

Interest Rates: Too Early to Anticipate Fed Rate Hikes

The FOMC kept the federal funds rate unchanged in June as we expected, but inflation risks turned policymakers more hawkish. Investors now anticipate roughly 40 basis points in rate hikes before year end — a sharp recalibration from before the conflict. New Fed Chair Kevin Warsh has begun implementing regime changes he signaled during his confirmation process.

Our latest forecast anticipates the Fed will keep rates steady for the rest of 2026. We have likely passed the peak in inflation, so expect Fed officials to refrain from tightening. We see the Fed resuming its easing in 2027 after inflation risks recede more meaningfully.

Equities: The Rally Hits Pause Button

Equities are down from their all-time highs despite lower oil prices and buoyant corporate earnings. The recent tech selloff and elevated interest rates are making investors slightly more cautious. High-profile IPOs may also explain the decline as investors make cash available to invest in these companies.

The selloff is modest by historic standards, with the S&P 500® index down about 2.5% from its all-time high. Buoyant corporate and economic fundamentals should keep the equity market on a healthy track. AI will likely continue to lead the charge and other sectors should contribute positively as well.

To find more information about the state of the economy, listen to Economic Insights By Nationwide wherever you listen to podcasts.