Output is pegged to increase at a 1.8% real annualized rate for the April‑through‑June quarter. This median nowcast marks a modest downshift from the 2.1% increase in Q1. The Bureau of Economic Analysis is scheduled to release Q2 data on July 30.

Recent nowcast updates show Q2 growth running slightly below Q1’s pace, although today’s estimate improved a bit from the previous report’s 1.5% advance. on July 7.

Yesterday’s release of the Federal Reserve’s Beige Book aligns with today’s modest nowcast estimate for the second quarter. “Economic activity increased at a slight to moderate pace in eleven of twelve Federal Reserve Districts in late May and June, while one District reported no change,” the report noted. “The pace of growth was quite close to that of last period, when activity expanded in ten Districts, was flat in one, and down in one.”

The Beige Book also reported that “Employment rose on balance, with five Districts showing modest, moderate, or solid gains in employment, and with seven Districts experiencing little to no change.”

A separate government release yesterday indicates labor‑market stability persisted last week as jobless claims edged lower. Initial unemployment filings fell 8,000 to 208,000 for the week ending July 11, the lowest since April and near recent cyclical lows.

Retail sales rose again in June, though at a slower pace than expected. The 0.2% monthly gain is the softest increase since January’s essentially flat reading.

“Despite challenges, consumers are still spending and the labor market shows no signs of cracking,” Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management, wrote in a research note yesterday. “This type of data won’t move the Fed’s needle either way, but it underscores the ongoing resilience of the US economy.”

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The possibility of a hawkish pivot came into focus this week after comments from three of the central bank’s policymakers. Governor Christopher Waller set the tone on Monday, noting that raising interest rates may be necessary in the “near term” if inflation continues running well above the 2% target. “Sternly staring at inflation until it melts before our withering gaze is not an option,” he told the New York Association for Business Economics.

On Wednesday, the government published data that highlighted cooler inflation figures for June, which ease the pressure for rate hikes, at least on the margin for the immediate future. The year-on-year change in the headline measure of the consumer price index (CPI) moderated for the first time since January. Core CPI, which strips out food and energy and is said to be a more robust measure of the pricing trend, also fell back.

Shortly after the CPI report was released yesterday, Fed Chair Warsh told the House Financial Services Committee that he and his colleagues “have no tolerance for persistently elevated inflation.”

Later on Wednesday, Fed Governor Lisa Cook said, “I see it as prudent to give a bit more time to observe how inflation unfolds from here.” Speaking at the Exchequer Club of Washington, D.C., she added: “Going forward, though, I believe the risks continue to be strongly weighted toward higher inflation for at least two reasons.”

One reason is related to the rapid rise in the AI-driven building of data centers, she noted. The second is “the recent big supply shocks—tariffs and the Middle East conflict—that risk leading to persistently higher inflation.”

Despite the hawkish comments this week, yesterday’s CPI data strengthened the market’s view that the Fed would leave its target rate unchanged at the next FOMC meeting on July 29. The Fed funds futures market is currently estimating a 90% probability of standing pat later this month. The outlook for a rate change at the September meeting, by contrast, is roughly a coin toss estimate.

The return of military strikes by the U.S. and Iran in the Gulf region in recent days raises uncertainty about the disinflationary pulse that emerged in the June CPI report. Absent the war, core inflation’s trend would likely ease in the months ahead, based on a model updated each month in The US Inflation Trend Chartbook, which is part of the research service for subscribers to The U.S. Business Cycle Risk Report, an affiliate publication of The Capital Spectator. In line with recent updates, the model’s current estimate shows the one-year change for core CPI easing in the near term, based on the point forecasts. Keep in mind, however, that the model is purely econometric and doesn’t factor in geopolitical risk.

The question is whether the softer inflation in June is outdated now that military actions in the Middle East have resumed, curtailing energy exports through the Strait of Hormuz again and driving up oil prices. Because of the renewed fighting, tanker traffic through Hormuz fell late last week, abruptly halting a brief recovery that followed the fragile ceasefire between the U.S. and Iran — an agreement that has collapsed this week.

The U.S. benchmark for crude oil (WTI) has rebounded in recent days to just under $80 a barrel, but remains far below the levels reached earlier in the war. For the moment, the inflation impulse from energy remains relatively moderate.

The clock is ticking, warns Fatih Birol, executive director of the International Energy Agency (IEA). He predicts the global economy faces economic impacts within weeks as Middle East tensions re-escalate and tanker traffic through the Strait of Hormuz halts.

“If the Strait of Hormuz remains closed, we may again have some difficulty for global economies, including those in the region, developing nations, and Asia,” Birol explained in an interview with Bloomberg yesterday. “It is not months, it is weeks,” before major economic challenges return, he advised.

A new round of an energy shock could slow economic activity, and in turn translate into a disinflatinonary pulse, eventually. In the near term, however, pricing pressure would probably rebound if the Middle East crisis continues to deepen.

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Military strikes by the U.S. and Iran in the Gulf region have intensified in recent days. The U.S. hit Iran early Wednesday, launching heavier airstrikes and reimposing a naval blockade after Tehran attacked ships in the Strait of Hormuz, a key chokepoint for oil exports. As the two sides traded overnight strikes for a fourth straight night—amid President Trump’s threat of a ground invasion and infrastructure attacks—fears of a full‑scale war escalated on Wednesday.

The threat of renewed fighting may keep oil prices rising, which could slow or reverse the easing inflation trend reported for June, based on the Consumer Price Index (CPI). After running hotter for months, the 1‑year change in headline and core CPI cooled last month for the first time since January. But the revival of a disinflationary impulse may fade or even reverse if the Middle East crisis intensifies.

The 10‑year yield continues to trend higher, albeit in fits and starts. In yesterday’s trading, the benchmark rate closed slightly lower, at 4.59%, close to its recent peak near 4.70%.

The market premium for the 10‑year yield slipped to 38 basis points in June, marking the first month‑to‑month decline since February, according to The Capital Spectator’s average estimate for three models. Note that the softer spread was due to a drop in the monthly 10-year yield, in contrast to the model’s fair-value estimate, which continued to rise.

The current premium remains modest by historical standards and implies that the 10‑year note is offering a relatively attractive yield.

One caveat to consider: the model doesn’t factor in geopolitical risk. The renewed hostilities in the Gulf underscore why the recent easing in the market premium may prove fleeting. With the U.S.–Iran conflict again disrupting energy markets and reviving fears of a broader regional war, the inflation outlook is suddenly more fragile than it appeared just weeks ago. Oil remains the key transmission channel, and any sustained rise in crude prices threatens to re‑accelerate inflation expectations, push Treasury yields higher, and widen the market premium anew.

In short, the geopolitical shock has reintroduced a level of uncertainty that markets had begun to discount, leaving investors to reassess whether June’s disinflationary signals were a pause rather than a pivot.

So how is the economy actually performing?

One useful lens is the “big four” indicators of the business cycle—payrolls, consumer spending, personal income, and industrial production—and how their current trajectories stack up against the historical record since 1970. Together, they offer an insightful read on whether the expansion’s momentum is fading, firming, or simply treading water.

Let’s start with the labor market: the recovery in payrolls since the brief but dramatically sharp pandemic recession ended in April 2020 has been an upside outlier by historical standards. A key driver for the rebound is the snapback from unprecedented speed and depth of the loss when the economy effectively shut down during the early phase of the Covid‑19 shock. But as the chart highlights, the growth rate has slowed as the expansion ages. That’s unsurprising at this late stage of the recovery. After 75 months of expansion, the pace is naturally settling into a more mature phase of the cycle, which suggests that the labor market’s contribution to economic growth will continue to ease.

Consumer spending’s trend is stronger, which is somewhat surprising for several reasons. The macro shocks over the past couple of years—tariffs and Middle East conflict—looked like textbook threats to personal consumption expenditures. But supported by a resilient labor market, the appetite to consume has remained robust, despite one measure of consumer sentiment reflecting some of the weakest polling on record in recent months.

The solid growth trend in consumer spending is all the more striking when viewed alongside the relatively weak recovery in personal income since the pandemic ended. Income surged early in the pandemic thanks to the government’s Covid‑related stimulus, but the path since then has been one of the weakest—and at times the weakest—runs during economic expansions in half a century.

Finally, industrial output has been strikingly lackluster over the past several years. There are hints that activity in this sector is strengthening lately, but the flatlining that has prevailed for much of the time since the recovery began in early 2020 suggests a cautious outlook for industrial activity is still warranted.

The takeaway: the expansion is heavily reliant on consumer spending. That’s hardly surprising. The modern US economy has long run on the capacity of households to open their wallets. But hints that labor‑market growth has slowed while support from personal income and industrial activity remains weak suggest a degree of vulnerability for the economic outlook.

To be clear, a deeper analysis of current conditions points to low recession risk in the near term, based on this week’s edition of The US Business Cycle Risk Report. But with the Middle East crisis flaring again and oil prices rebounding, the economy’s heavy dependence on household demand makes the expansion look more fragile than the headline data suggests.

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Reviewing the major asset classes since the first US strikes on Iran on Feb. 28 reminds us that the risk appetite was dented but not broken, based on a set of ETFs through Friday’s close. US equities have led the winners by a wide margin: the Vanguard Total Stock Market ETF (VTI) is up nearly 11% since the start of hostilities.

Note, too, that a globally diversified portfolio has also rallied during this period, advancing more than 6%, based on the Global Market Index (GMI), an unmanaged benchmark (maintained by The Capital Spectator) that holds all the major asset classes (except cash) in market‑value weights via ETFs.

Yet a fundamental question is coming into focus as the conflict drags on and the US confronts the possibility that military force, at least in its current form, may not achieve the administration’s aim of reopening the Strait of Hormuz and restoring pre‑war flow of energy exports.

Senior Iranian officials escalated their threats in recent hours as the latest U.S.–Iran exchange of strikes continued into Monday. Neither side appears to be backing away from a cycle of attacks that is unraveling the cease-fire signed last month.

The main question for markets is bound up with the outlook for inflation. Although oil prices have dropped sharply over the past month — briefly returning to pre‑war levels in early July — crude has rebounded in recent days, albeit moderately relative to the spike in March and April. Even if energy prices remain relatively stable in the near term, it’s unclear whether the recent surge of energy‑driven inflation is bleeding into the wider economy, which would likely require a response from the Federal Reserve. In that scenario, a series of rate hikes may be near, creating stronger headwinds for financial markets.

The prevailing narrative to date is that the Iran conflict lifted headline inflation via energy prices, but that this shift was temporary. This account is under renewed threat as it becomes clear that the US has few options for restraining Iran from attacking shipping in the Gulf. Short of a full‑scale invasion — an unlikely scenario — it’s possible, if not likely, that gray‑zone conditions in the Gulf, somewhere between war and peace, will persist. In turn, these conditions could support an ongoing inflationary pulse that triggers a reaction from the Fed.

The week ahead will be an important test of how markets price in the risk that hotter inflation may linger longer than recently expected. The US 2‑year Treasury yield is on the front line of digesting investor sentiment around inflation risk. An upside breakout above the recent peak of roughly 4.25% would be a worrisome sign for markets generally.

The United States has backed itself into a corner with Iran, trapped in a retaliatory cycle that leaves little leverage to defuse the crisis or accelerate a quick reopening of the Strait of Hormuz. If the waterway stays constrained for longer than expected, the resulting pressure on energy markets could keep inflation elevated well past policymakers’ comfort zone — and it’s increasingly unclear how markets will react to this emerging risk.

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Oil prices rose earlier in the week on news that military action had resumed in the Gulf region, and Treasury yields moved higher as well. Markets were calmer on Thursday, however, with both oil and yields pulling back. Even so, it’s clear that expectations for the Iran crisis to keep fading as a geopolitical risk factor for markets and the global economy were premature.

There’s still a case for expecting inflation to ease in the months ahead, but the path may take longer than markets were anticipating before this week’s resumption of military strikes. The Cleveland Fed’s inflation nowcasts, published just before the latest round of hostilities, anticipated that pricing pressure would start easing in the upcoming June Consumer Price Index report and continue dipping in July. But the prospect of a long, uneven path to peace in the Middle East has dented the optimistic view.

One of the proprietary models The Capital Spectator monitors for tracking inflation has been showing a transition into a high‑inflation regime lately, based on data through May. The shift was notable since it wasn’t accompanied by a slowdown in economic pulse.

The task for the immediate future is monitoring if the recent move of the pricing trend, albeit modestly so, into the high inflation/high growth endures. It’s possible that the latest military strikes in the Gulf region will be one-off events that don’t derail efforts to normalize Middle East energy exports, in which case inflationary pressure will ease.

Yet this week’s events also remind that the pre-war calm is still nowhere on the near-term horizon. The potential for a long, protracted period of conditions that remain in a gray area between war and peace prevail.

The question is how markets price in a brittle equilibrium for the US-Iran conflict. Similarly, the Federal Reserve will struggle to make reasoned, timely decisions for monetary policy.

The latest release of Fed minutes, for the June 16-17 policy meeting, highlight that the central bank’s interest-rate setting committee remains split on the inflation outlook. This week’s events in the Middle East will likely strengthen the policy debate well into the future.

The minutes outlined two key scenarios: if inflation stays high and broadens, most Fed officials are ready to raise rates; if inflation steadily falls, most prefer to hold rates steady or eventually cut them.

“I do think [the minutes] showed that richness of these scenarios,” New York Fed President John Williams said on Thursday. “There are certain parts of the inflation outlook that are probably maybe a little bit more benign, say on the tariffs, maybe on the energy prices, depending how that plays out. But there are other scenarios where inflation is more persistent and stays higher, which would … call for tighter monetary policy. I think that’s the right way to think about it.”

Fed funds futures continue to price in moderately high odds for keeping the target rate unchanged at the next FOMC meeting on July 29, followed by modest shift in favor of a rate hike in September.

The wild card, of course, is still Iran, and will likely remain so for weeks if not months, or even longer. With no obvious path out of this box in the near term, markets will struggle to find a degree of comfort with elevated Middle East uncertainty that persists.

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Perhaps the most surprising trend since the conflict began: bank loans have outperformed the rest of the field by a wide margin, based on a set of ETFs through yesterday’s close (July 8). The Invesco Senior Loan ETF (BKLN) continues to lead, rallying more than 3% since Feb. 28 — roughly double the gain of the next‑best performers.

Meanwhile, most Treasuries and the investment‑grade benchmark — Vanguard Total Bond Market (BND) — remain underwater since the war began. The biggest loss: long Treasuries (TLT), down more than 5%.

One explanation is that the war has lifted inflation and fueled expectations that the Federal Reserve will soon be forced to react by raising interest rates. Add in growing concerns about the still‑unaddressed rise in federal debt, and incentives are in place to think differently about safe havens.

Bank‑loan securities surged because the war in Iran flipped the usual risk playbook. Investors rushed to floating‑rate, senior‑secured credit, which suddenly looked safer than the long‑duration assets that typically anchor defensive portfolios.

BKLN holds floating‑rate, senior‑secured junk loans. The ETF’s strength in recent months suggests investors are eager to chase higher yields while sidestepping interest‑rate risk. They’re willing to take on a bit more credit risk to lock in coupon income and seek protection from future rate hikes.

On that basis, it’s no surprise that the second‑best performance during the war is essentially a tie between a dedicated floating‑rate note ETF (FLRN) and a short‑maturity junk‑bond fund (SJNK).

This isn’t a free lunch, however. Investors should be aware of three pressure points for BKLN and other funds favoring floating‑rate loans issued by relatively highly leveraged borrowers: shrinking income if the Fed cuts rates, leveraged borrowers vulnerable to tightening credit, and an underlying loan market prone to sudden liquidity freezes.

The crowd’s preferences remain clear, and BKLN’s strength is conspicuous relative to the investment‑grade benchmark (BND) since the war started.

To the extent that the Middle East conflict has persuaded investors to favor BKLN and similar portfolios, this week’s news flow suggests geopolitical risk will remain elevated. Renewed military strikes in the Middle East have jolted markets by reviving fears that the region’s fragile calm is slipping back into open conflict.

If war and geopolitical uncertainty have been bullish factors for BKLN and its counterparts in recent months, the near‑term outlook still looks supportive for this slice of the fixed-income market.

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The path ahead for the Middle East crisis remains uncertain, and monitoring key indicators that serve as proxies for market sentiment has returned to the fore. Hanging in the balance as the conflict twists and turns anew: inflation risk, economic activity, monetary policy, and the risk appetite across financial markets.

The price of crude oil remains on the front line of real‑time reaction, and so it’s not surprising that the weeks‑long slide sharply reversed this week. As the trading week began, the war premium had fully unwound, and WTI (the U.S. benchmark) briefly traded under $70 a barrel. The rebound to above $74 on Tuesday keeps prices at the low end of the range that has prevailed since the first attacks on Feb. 28. If oil continues to climb, many of the recent assumptions about a disinflationary pivot will come under renewed scrutiny.

A similar reversal has unfolded in the U.S. 10‑year Treasury yield, which jumped to 4.56% on Tuesday. That’s a sign of renewed anxiety tied to the latest round of conflict in the Gulf and the potential for a renewed inflation pulse.

The stock market remains relatively calm as the S&P 500 Index continues to trade in a range, but the stoic sentiment will be tested as the murky conditions of the Middle East play out in the days and weeks ahead.

The moderate rebound in confidence that the Federal Reserve might be able to delay or sidestep rate hikes is under renewed pressure. Although markets are still pricing in moderately high odds for no change in monetary policy at the next FOMC meeting on July 29, the probability of a rate hike in September is estimated at roughly 66%, based on Fed funds futures.

The danger here is what appears to be Iran’s emerging game plan: holding out for increased leverage ahead of the November U.S. midterm elections rather than pursuing a deal with the Trump administration. By driving up oil prices and Treasury yields, the regional conflict threatens to force a more hawkish Federal Reserve stance, leaving the U.S. economy exposed to the long‑term consequences of Mideast instability.

Given the mercurial decision‑making on both sides, the outlook remains highly fluid. Once again, watching how oil prices and Treasury yields reprice the latest spike in geopolitical risk is essential for monitoring the crisis.

As Yogi Berra famously said, “It ain’t over till it’s over,” and it definitely ain’t over.

Growth for Q2 is currently estimated at a sluggish 1.5% (real annualized rate). The new median nowcast marks a material slowdown from the 2.1% increase reported for Q1.

Today’s revised Q2 estimate marks a significant downshift from the 2.5% estimate in our previous update (June 22).

The softer nowcast reflects three factors in recent data: lower exports, a decline in expectations for consumer spending, and cooler forecasts for domestic investment. The combination of these changes has weighed on some nowcasts, including the Atlanta Fed’s GDPNow model, which is currently nowcasting Q2 growth at just 1.2% (July 1) — down sharply from 3%-plus a few weeks earlier.

But some economists say the downshift is less worrisome than it appears and is mostly an accounting-based adjustment rather than a genuine decline in economic activity. Renaissance Macro Research, citing the softer GDPNow estimate, last week noted:

We wouldn’t get too carried away with this. While Q2 GDPNow is lower, the bulk of the recent drop stems from a wider trade gap. Excluding net exports and inventory investment, private domestic demand is tracking close to 2.5 percent, which is respectable.

The strongest nowcast in the chart above is the New York Fed’s 2.74% estimate (July 3) — essentially unchanged in recent weeks and well above GDPNow’s 1.2%, the weakest of the group.

The government’s official Q2 report is scheduled for July 30, leaving the possibility that incoming data could revive the weaker estimates. As for The Capital Spectator’s view, our standard practice is to use the median as the best real‑time guesstimate.

If the optimists are right and Q2 activity is stronger than some nowcasts suggest, the median will move higher in the weeks ahead of the official data.