Cooling Employment and Inflation Reduce the Need for Further Policy-Rate Increases
AI summary card
Cooling Employment and Inflation Reduce the Need for Further Policy-Rate Increases
Goldman Sachs believes U.S. consumption will slow, the labor market is not tightening, and core PCE inflation could approach 2% in 2027; therefore, market pricing for Fed rate hikes remains too hawkish.
- U.S. real consumption growth is expected to slow to 1% to 1.5% in the second half of 2026, pressured by stagnant real cash flow.
- Underlying trend employment growth in July is estimated at only 5,000, below the roughly 50,000 breakeven pace of job growth.
- Core PCE is expected to rise by about 0.20% month-on-month in July, while Goldman Sachs expects it to decline toward 2% in 2027.
- European equities' earnings and valuation structure are stronger than implied by the macro narrative and remain relatively attractive.
- A prolonged closure of the Strait of Hormuz could lift gasoline prices and intensify pressure on consumers, while potentially reducing global oil inventories to historical lows.
Report interpretation
Overview
The report presents eight views on global growth, inflation, and policy prospects. Its core conclusion is that U.S. employment and inflation are softening, consumption growth will decelerate, and near-term Fed rate hikes are highly unlikely; meanwhile, opportunities remain in European equities, risk assets, carry trades, and selected energy-related themes.
Core views
The strength in U.S. real consumption during the spring was driven primarily by a surge in tax refunds and is unlikely to persist; job growth, wage growth, and participation do not support the view that the labor market is tightening. Temporary inflation drivers should gradually fade, allowing core PCE to approach 2% in 2027. Accordingly, a September FOMC rate hike is extremely unlikely, and market pricing for the federal funds rate remains too hawkish. The ECB is expected to raise rates by 25 basis points in September, but its next policy move could shift to cuts by mid-2027. European equities benefit from sector composition, earnings performance, and lower valuations; China, meanwhile, needs both renminbi appreciation and stronger domestic demand to improve external imbalances.
Analysis framework
The report uses a macro data-tracking and cross-asset allocation framework, combining indicators including consumption, employment, inflation, central-bank policy, valuations, earnings, exchange-rate competitiveness, polling, and energy inventories to assess the relative outlook for major economies and asset classes.
Methodology notes
Trend employment is estimated using 0.75 times the three-month average nonfarm payroll growth plus 0.25 times the nine-month average household-survey employment growth.
This indicator is used to identify underlying labor-market momentum; the report estimates it was only 5,000 in July.
Changes in employment and core inflation are used to assess the policy-rate path.
Continued softness in employment and inflation reduces the need for further rate hikes and supports a reassessment of hawkish market pricing.
Exchange-rate adjustment and domestic-demand policies must work together to achieve internal and external balance.
The report argues that China needs significant renminbi appreciation alongside measures such as stronger social security to boost domestic demand, in order to improve external balance without materially harming growth and employment.
Election polling is used to assess candidates' probabilities of winning.
The model indicates that Marine Le Pen currently has roughly a two-thirds probability of being elected president of France, with the composition of the second-round opponent being a key variable.
Asset mapping & comparison
Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).
- U.S. TreasuriesBeneficiary of lower expectations for Fed rate hikes and improving inflation.
- Strengths
- A declining rate-hike premium supports further steepening of the yield curve.
- Weaknesses
- Fiscal concerns may limit declines in long-end yields.
- Comparison
- Relative to current market pricing, the report believes the rate path is priced too hawkishly.
- Risks
- An unexpected rebound in inflation or a material strengthening in economic data.
- European EquitiesThe report remains positive on European equities, including the United Kingdom.
- Strengths
- More favorable sector composition, more resilient earnings, and lower valuations than the United States; European banks have performed strongly since 2022.
- Weaknesses
- The macro growth narrative is weak, and part of the gains may already reflect a one-off valuation rerating.
- Comparison
- The Stoxx 600 has outperformed the S&P 500 over the past 18 months, while European banks have significantly outperformed U.S. large-cap technology stocks.
- Risks
- French political uncertainty, energy shocks, and downward earnings revisions.
- Chinese RenminbiA stronger renminbi is needed to achieve external balance.
- Strengths
- Appreciation could reflect improved manufacturing competitiveness and an undervalued exchange rate.
- Weaknesses
- Appreciation alone could further suppress weak domestic demand and growth.
- Comparison
- The report argues that exchange-rate appreciation and demand stimulus are not substitutes and should be implemented simultaneously.
- Risks
- Insufficient support for domestic demand and growth falling further below potential.
- Crude OilBullish amid supply disruptions.
- Strengths
- Recovering global demand and rapidly falling inventories; a continued closure of the Strait of Hormuz would intensify tightness.
- Weaknesses
- High oil prices would harm consumers and overall growth.
- Comparison
- Higher energy prices are negative for European GDP, but may not be negative for European equities given the relatively high weight of oil companies.
- Risks
- Reopening of the strait, weaker demand, or supply recovery.
Key data
- Forecast for U.S. Real Consumption Growth1% to 1.5% in the second half of 2026Stagnant real cash flow is expected to slow consumption.
- U.S. Underlying Trend Employment GrowthAbout 5,000 in JulyBelow the estimated breakeven job-growth pace of roughly 50,000.
- U.S. Unemployment Rate4.5% in December 2025; 4.1% in July 2026The decline was driven primarily by lower labor-force participation rather than stronger employment.
- Month-on-Month Core PCE0.13% in June 2026; about 0.20% expected in July 2026More than half of the July increase came from portfolio management services, a component that may subsequently be revised down.
- Core PCE Inflation ForecastClose to 2% in 2027Temporary drivers such as tariffs, software and accessories, and energy are expected to gradually fade.
- ECB Policy Expectations25-basis-point rate hike in September 2026; next move shifts to cuts by mid-2027Based on the view that energy prices are higher but core inflation is only slightly above target.
- Stoxx 600 Earnings per Share Growth14% in the first half of 2026Nominal GDP grew 3.3% and real GDP grew 0.7% over the same period.
- Renminbi ValuationAt least 20% undervaluedEstimate based on relative producer prices and changes in manufacturing competitiveness.
Impact & implications
Rate markets should further price out the rate-hike premium, potentially causing the U.S. Treasury curve to steepen further. In equities, strong second-quarter earnings and stabilization in the AI trade support continued gains in major indices into year-end; European equities have relative advantages due to sector composition, earnings, and valuations. In foreign exchange, a moderate global inflation environment favors carry trades; in commodities, if the Strait of Hormuz does not reopen soon, declining oil inventories will reinforce upside risks to oil prices.
Risks
- A prolonged closure of the Strait of Hormuz could trigger another surge in gasoline and oil prices, pressuring low- and middle-income consumers.
- U.S. employment or inflation data could unexpectedly strengthen, reviving expectations for rate hikes.
- France's 2027 presidential election could create volatility in European politics and risk premia.
- Renminbi appreciation without accompanying domestic-demand policies could weigh on growth and employment.
- Heavy issuance of AI-related data-center debt could widen credit spreads.
What to watch
- U.S. August employment, wages, labor-force participation, and core PCE data.
- The September FOMC meeting and changes in federal funds rate market pricing.
- The ECB's September policy decision and 2027 policy expectations.
- French presidential-election polls and potential second-round candidate matchups.
- The renminbi exchange rate, domestic-demand support policies, and manufacturing price competitiveness.
- Navigation conditions in the Strait of Hormuz, global crude-oil inventories, and oil prices.
- European corporate earnings, Stoxx 600 valuations, and the relative performance of European banks.