Connor Hare

The ongoing government shutdown became the 2nd longest in history this week, as it stretched into week 4. With divisions in Congress largely unchanged relative to September, a resolution remains out of sight, but as the economic impacts become more material, intransigence will likely yield. Elsewhere in D.C., President Trump called off trade negotiations with Canada over the use of anti-tariff television advertisements broadcast in the U.S., forestalling a near-term trade agreement with the nation’s second largest trading partner. Despite political dysfunction in the Capitol and rising trade tensions in recent weeks, the S&P 500 still managed to rise 2% this week from a host of positive third quarter earnings reports.

While the Department of Labor remains unfunded, the CPI data for September was released on Friday owing to its use in the annual inflation adjustment to social security payments. The data showed that recent inflationary pressures moderated slightly in September but remained elevated on aggregate, with the three-month annualized percentage change in core CPI running above 3.5% (Chart 1). With price growth still well above the Fed’s 2% target and the timing of future data releases uncertain, policy decisions are expected to be cautious moving forward.

The shift in the Federal Reserve’s stance on monetary policy over the past few months came on the heels of a slowdown in the labor market, tracking of which has been obscured by the lapse in data releases. As the FOMC begins deliberations next week, they will likely assume that the slowdown persisted through September and opt to meet financial market expectations for a quarter-point rate cut. Chair Powell’s press conference will be closely watched for insights into how the policy response function of the Federal Reserve will adapt to a prolonged government shutdown, as inference becomes more difficult the further we are from the last official data release.

On the trade front, U.S. Treasury Secretary Bessent will be meeting with a Chinese delegation in Malaysia over the weekend. The deadline to reach some form of agreement is becoming tight, with President Trump’s threat of 100% tariffs on China starting November 1st. The President will also be travelling to Asia Friday night, with plans to visit Malaysia, Japan, and South Korea, culminating with the Asia Pacific Economic Cooperation (APEC) summit where he is expected to meet with his Chinese counterpart. Amid rising trade tensions in recent weeks, financial markets will be watching for any signs of de-escalation.

Markets will also be watching for several big tech earnings reports next week, including Microsoft, Apple, Alphabet, Amazon, and Meta, which collectively account for nearly a quarter of the S&P 500 (Chart 2). Given the high level of concentration in equity markets, growing concerns about elevated valuations, and the influence of these trends on the economy, these results will be monitored closely on the heels of Wednesday’s Federal Reserve decision.

This week’s U.S. economic landscape remained shrouded in fog due to the lack of official data amidst the ongoing government shutdown. If it continues until Monday, it will be the third longest in history. In the official data drought, focus has shifted to alternative indicators, particularly from the Federal Reserve, which is still operating during the shutdown. US-China trade tensions ebbed and flowed, while concerns surrounding regional banks made a comeback, weighing on equity markets. Still, equities managed to eke out some gains, with the S&P 500 up 1% from last Friday’s low. Bond yields declined amid uncertainty and expectations of further monetary easing. Notably, the 10-Year Treasury yield fell below 4% and is now hovering near last year’s level.

In the absence of the CPI report, alternative inflation indicators are sending conflicting signals. The Cleveland Fed’s Inflation Nowcasting model estimated core inflation at 0.26% month-over-month in September, suggesting year-on-year core inflation remained near 3%. The lack of acceleration would support another Fed rate cut amidst a deteriorating labor market. However, the Fed’s Beige Book reported further price increases, with several districts noting “faster input cost growth due to higher import prices and rising costs for services like insurance, health care, and technology”. The NFIB’s small business survey also showed moderate upticks in its price metrics (Chart 1). The CPI report is set to be released next week, which should help clear some of the fog.

The September retail sales report is also delayed, but the Chicago Fed’s Advance Retail Trade Summary (CARTS), which tracks weekly sales, offers some insight. CARTS indicates that retail & food services sales excluding autos rose by 0.5% in September, suggesting a solid finish to the third quarter (Chart 2). However, given ongoing uncertainty and other consumer challenges, momentum is expected to ease in the fourth quarter. The Beige Book echoed this, noting that overall consumer spending, especially on retail goods, trended down in recent weeks, with auto sales being the main exception.

On the employment front, the Beige Book described labor demand as “subdued” and employment levels as “largely unchanged”. More employers reported lowering headcount through layoffs and attrition, citing weak demand, high uncertainty, and, in some cases, increased investment in AI. Layoffs were mentioned 14 times, up from 6 previously. NFIB employment metrics also pointed to a weak hiring trend among small businesses in September.

Fed Chair Powell reiterated recent messaging and placed more emphasis on labor market risks in a speech this week, supporting additional easing. Powell also signaled the central bank could soon stop reducing the size of its balance sheet. While he provided no set timeline for the end of quantitative tightening (QT), he stated “we may approach that point in the coming months,” noting early signs that liquidity conditions are gradually tightening.

Reading the tea leaves, labor market risks remain the key focus. As such, the Fed is likely to deliver another rate cut at the end of this month. The signal that QT may soon end further reinforces the Fed’s dovish stance.

Up until Friday, markets had been relatively calm amid the ongoing government shutdown, which has entered its 10th day. President Trump’s threat to increase tariffs on China this morning, in response to China’s export controls on rare-earth metals, has upended that. President Trump has gone so far as to declare he is not interested in meeting President Xi in person as previously scheduled for the end of the month, leading to a sharp sell-off in US equities and pushing Treasury yields lower. Markets stoically withstood the failure of seven separate proposals to re-open the government, but the possible breakdown of U.S.-China trade negotiations may be too much to bear. If that wasn’t enough, the end of the shutdown is not clearly in sight. The Senate is now adjourned until October 14, which all but guarantees that military members will miss a full pay cycle, an unprecedented development.

The outlook for the shutdown is not the only thing that is cloudy. The government shutdown means that official economic data are not being published, and policymakers, businesses, and households are unable to see new data on the state of the economy. Various private-sector groups have produced estimates of what happened to employment in September, shown in Chart 1. This was the key piece of data which was due to be published last Friday. While these alternative estimates generally suggest the labor market continued to cool through September, these measures are at best imperfect proxies for the official data. As for what data we do have this week, the preliminary reading of the University of Michigan’s consumer confidence ticked a touch higher in October. However, expectations on the future outlook continued to slide for a third consecutive month, likely driven by the softening labor market and still elevated uncertainty on trade policy.

Several members of the FOMC spoke this week, offering some insight into their thinking amidst the shutdown. New York Fed President Williams indicated that the lapse in government data would not deter him from further easing the policy rate at the Fed’s coming meetings. Meanwhile, other speakers continued to reiterate prior views. Kansas City Fed President Schmid voiced concern about inflation, while Miran, the only FOMC member to vote for a larger 50 basis point rate-cut at the last meeting, again indicated how he expected inflation to moderate. It is little surprise that market pricing at the next Fed meeting has remained relatively unchanged through the government shutdown. Expectations for further easing at a moderate pace are in line with the general view we observed in the FOMC minutes released this week, that interest rates are currently moderately restrictive and risks have shifted somewhat to the downside.

Normally, we would be looking ahead to next week’s release of CPI for more information on how prices are reacting to tariffs, but we are following the shutdown. We will also be closely watching trade negotiations between the U.S. and China to see what comes of today’s escalation.

On October 1st, the U.S. government shut down all “non-essential” services, as Congress failed to pass a bill necessary to fund government in the current fiscal year. Financial markets have shrugged off the shutdown so far, with equities ending the week higher, bond yields declining, and the U.S. dollar weakening only slightly. In past shutdowns in 2013 and 2018, equities and the USD declined modestly and recovered quickly, so the reaction this time is even more muted.

If this shutdown is brief, the markets may be right to discount it. Most lost output in previous shutdowns was eventually recovered. Studies show shutdowns reduce annualized quarterly real GDP growth by up to 0.1 percentage points for each week. However, negative effects increase non-linearly the longer the shutdown lasts as disruptions accumulate (report).

The lack of updated official economic data is another casualty of the shutdown. September’s payrolls release has been postponed. A prolonged shutdown may delay other key indicators like the Consumer Price Index (CPI). A lack of official data complicates decision-making for the Fed. For now, the Fed will have to rely on private and internal data sources. Earlier this week, Chicago Fed President Goolsbee (who is a voting member of the FOMC) echoed that, but also acknowledged that it worries him “that we wouldn’t be getting official statistics at exactly a moment when we’re trying to figure out is the economy in transition.”

Without official payrolls data, employment surveys—such as ADP and JOLTS—filled the gap. The ADP report showed continued weakness in job growth in September, with private payrolls declining by 32,000. Though ADP data can be volatile, recent trends show greater alignment with payroll figures through 2025, especially on a three-month moving average (Chart 1). The August JOLTS report, released before the shutdown, also showed a hiring drought, with job openings below the number of unemployed for a second consecutive month (Chart 2). Although job opportunities were scarce, layoffs have remained subdued. Employers seem to be in “low hire, low fire” mode, supporting stability in the unemployment rate and helping to cushion consumer spending for now.

In terms of economic growth, ISM indexes pointed to slowing momentum in September, with businesses increasingly citing the growing impact of tariffs on their bottom lines. The ISM manufacturing index edged higher, but remained in contractionary territory, with only 5 out of 18 industries reporting growth. Activity moderated in the services sector, with the ISM non-manufacturing index declining to 50.0 from 52.0, narrowly avoiding slipping into contraction. Details were disappointing: new orders and business activity moderated, prices rose and the employment subcomponent remained in contractionary territory. While limited, this week’s data continues to support the case for additional monetary stimulus from the Fed, with another rate cut in October being nearly priced in by markets.

Numerous Fed speeches, a looming government shutdown, and a handful of new tariff announcements made for a busy week. Chair Powell’s remarks on Tuesday were parsed for any hints surrounding the Fed’s next move. However, Powell stuck to the script, reiterating the challenging environment faced by policymakers due to rising inflation and a weakening labor market. But fears of a softening economy were lessened this week, following an upward revision to Q2 GDP, a healthy read on August personal income & spending and a sharp drop in jobless claims. Meanwhile, President Trump’s announcement on Thursday evening to impose a 100% tariff on pharmaceuticals, 25% on heavy trucks, and 50% on furniture did little to jar markets. The S&P 500 is trading slightly higher on Friday morning but looks to end the week 0.6% lower.

In recent years, the threat of a government shutdown has become a regular occurrence marking the beginning of each new fiscal year. This year appears to be no different. House Republicans passed a ‘clean’ continuing resolution (CR) on September 19th that would have funded the government through November 21st. However, the bill failed to garner the 60-vote majority required to pass the Senate. Meanwhile, Senate Democrats put forward a separate CR, which came with several provisions, including a permanent extension to the expiring expansions of the Affordable Care Act subsidy. The bill had no chance of passing the Senate, but was meant to serve as a stake in the ground from which Democrats hoped to negotiate. However, this all backfired on Tuesday when President Trump cancelled his meeting with top Democratic leaders. With both the House and Senate on recess until next week, odds now heavily favor a government shutdown come October 1st (see report).

Turning to the economic data, the third revision to Q2 GDP showed a notable upgrade to growth (3.8% from 3.3%). Nearly all the additional strength came from consumer spending on services (2.6% from 1.2%) and business investment (7.3% from 5.7%). As a result, final sales to private domestic purchasers – our best gauge of underlying demand – was revised to 2.9% (from 1.9%), suggesting a more resilient economy (Chart 1).

Encouragingly, the new-found momentum looks to have carried into Q3. Personal spending for August advanced 0.35% m/m (Chart 2), while income growth also remained healthy. Elsewhere, durable goods orders – a leading indicator of CAPEX – also came in on the hotter side. After incorporating this week’s data, our Q3 GDP tracking is now north of 3%.

But even with the renewed strength, the labor market remains an ongoing concern for the Fed. Higher frequency data on jobless claims and job openings suggest conditions have stabilized in the ‘low hire, low fire’ environment, but next week’s payrolls report will be key in shaping the Fed’s next move. However, a government shutdown would delay its release, leaving both policymakers and market participants in the dark.

The Federal Reserve resumed its easing cycle after a nine-month pause, cutting the policy rate by 25 basis points at this week’s FOMC meeting. The move was widely anticipated, and while bond yields initially dipped, they ultimately rose as markets digested the broader implications. Equities, however, rallied, with the S&P 500 climbing another 1% on the week at time of writing.

The FOMC statement signaled a shift in emphasis from the ‘price stability’ mandate toward ‘full employment’, noting that “downside risks to employment have risen”. This echoed Fed Chair Powell’s remarks at Jackson Hole last month and set the tone for what he later described as a “risk management cut”. In essence, while inflation remains elevated, the Fed deemed it prudent to begin easing the policy rate to help guard against further labor market deterioration.

The decision was accompanied by the latest Summary of Economic Projections (SEP), which offered a mixed picture. Unemployment rate forecasts were largely unchanged, while growth projections for 2025 and 2026 were nudged up 20 basis points (bps) to 1.6% and 1.8%, respectively. Core inflation expectations for next year were also bumped up by 20 bps to 2.6%, with this measure now projected to return to target only by 2028 – which would mark seven consecutive years above the Fed’s 2% goal. The median forecast now calls for three cuts by year-end (including this week’s) up from two, and is in tune with our expectations. But one member projected the equivalent of three jumbo 50 bps cuts total (Chart 1). Stephen Miran, President Trump’s newly appointed Fed governor, is likely the one projecting more aggressive cuts as he was the lone dissent at this week’s meeting, favoring a larger 50 bps cut.

Economic data released this week did little to bolster the case for continued easing. Initial jobless claims fell back last week, following a surge in the week prior. And while housing remained a soft spot, with homebuilding pulling back in August, consumption-related data came in better than anticipated. August retail sales and food services rose 0.6% on the month, matching July’s gain. Sales in the ‘control group’ – which strip out volatile components – rose a solid 0.7%, building on gains in the prior two months (Chart 2). While tariffs are still expected to chip away at spending power and weigh on consumption, this recent data suggests consumers may still have some gas in the tank.

The bottom line is that while the Fed has resumed rate cuts to guard against further labor market weakness, its “risk management” approach means future moves will remain highly data dependent. The Fed will continue to have a hard time balancing the risks with respect to its dual mandate. But ultimately, we believe that the tariff impact on inflation will be temporary, and we expect the central bank to continue to cuts rates to support the economy (see our latest Quarterly Economic Forecast here).

Despite there only being a handful of economic data releases this week, each was influential to the economic outlook. This included the preliminary benchmark revision for employment, as well as the consumer and producer inflation reports for August. While the data was somewhat concerning, financial markets largely took it in-stride as expectations for next week’s Federal Reserve decision remained in-tact. The S&P 500 rose 1.6% on the week, with U.S. Treasury yields seeing little change as of the time of writing.

The preliminary revision to non-farm payrolls released on Tuesday will not be incorporated into the official data until the January 2026 release, but the snapshot it provided was concerning. Estimates of employment for the year through to March 2025 were revised lower by 911k jobs, which would be the largest revision since 2009 (Chart 1). This comes on the heels of last week’s employment report for August, which showed only 22k jobs added during the month and the unemployment rate rising to 4.3%. The emerging shift away from full employment in the economy is likely to be a top priority during Federal Reserve deliberations at next week’s meeting.

However, they will also have to assess the emerging risks to the other side of their dual mandate related to price stability, with the data we received this week on inflation also raising concerns. Those with dovish predispositions may point to the surprise decline in the producer price index (PPI) in August as evidence that price pressures are under control. However, the rolling 12-month volatility of the PPI final demand index excluding food & energy has hit its highest level since mid-2022, likely reflecting the impact that constant trade policy changes have had on firm pricing decisions. Single-month changes in the PPI therefore need to be taken with a grain of salt and illustrate the challenges the Fed faces in assessing price developments in 2025.

On the consumer inflation front, we saw further upward pressure on goods prices in August, while services inflation also remained elevated. With the three-month annualized percent change in core CPI accelerating to 3.6% in August (Chart 2), the Federal Reserve’s response function would typically be to consider raising interest rates in such an environment, all else equal. However, given the temporary nature of tariff-induced inflation and the flagging labor market, the full balance of risks will need to be taken into consideration. Amid this backdrop, in conjunction with the sustained stability in consumer inflation expectations, we expect the Fed to implement its first 25 basis point cut of the year next week.

Further interest rate reductions are expected to be implemented gradually through the end of the year, to provide support to the economy without fanning the flames of inflation anew. This is expected to be a delicate maneuver by the Federal Reserve, and one that will be sensitive to the balance of incoming economic data.

This was a short but volatile week in financial markets. Earlier in the week, equities and bonds sold off amid growing concerns about the long-term sustainability of government debt in the U.S. and other developed nations. These concerns stemmed from increased borrowing needs and reduced demand for government bonds, particularly from central banks. Long-dated bonds were particularly under pressure, with the gap between 30-year and 10-year Treasuries rising to 0.7 percentage points—the highest since 2021.

In the U.S., fears were amplified by questions around the Federal Reserve’s independence and inflation risks linked to tariffs. Adding to the fiscal alarm was a court ruling that IEEPA tariffs were imposed illegally. The case now heads to the Supreme Court, and if the decision stands, it could jeopardize this revenue stream and leave the government liable for billions in refunds.

However, sentiment reversed on Wednesday, with bond yields falling and equities rising. It was a classic case of “bad news is good news,” as softer-than-expected economic data – namely the lower job openings in the JOLTS report – boosted expectations of more aggressive rate cuts from the Fed. Given last month’s downward payroll revisions and modest job gains, investors were already on alert for signs of ongoing labor market weakness ahead of Friday’s payroll report. They didn’t have to look too hard.

August’s payroll report confirmed that the labor market is softening quite quickly (Chart 1). Job growth was well below expectations in August, with just 22k new jobs added,  and has averaged only 29k over the past three months (see commentary). Goods-producing industries, especially those exposed to tariffs, continued to shed jobs for a fourth straight month. Government employment also declined. The services sector added 63k jobs, but gains were not broad-based. Education & health added 46k jobs and 28k were in leisure & hospitality. While employers are not rushing to hire, they aren’t cutting jobs en masse either. Still, the jobless rate edged up to 4.3% from 4.2% the prior month, reaching a new post-pandemic cyclical high.

Playing second fiddle to the payrolls number, the July JOLTS data also surprised with weaker-than-expected job openings, which declined to 7.18 million from 7.36 million. Openings also fell below the number of unemployed for the first time since 2021—though the margin has been narrow since mid-2024 (Chart 2). Quits and layoffs were little changed, suggesting the economy remains in a “low hiring, low firing” state.

Fed officials have recently become more concerned about the downside risks to the labor market, and the August payrolls report shows these concerns are valid. As such, we maintain our view that the Federal Reserve would need to deliver 75 basis points in rate-relief this year, with the first one coming in less than two weeks.

President Trump continued to pressure Federal Reserve officials this week, this time attempting to fire Governor Lisa Cook for alleged mortgage fraud. The situation remains influx, as Cook is contesting the President’s actions in court. But the mere threat of her removal has sparked further concerns of central bank independence, sending shorter-term yields lower. The yield curve steepened on the week, with the 30-to-2-year spread widening to its highest level since early-2022 (Chart 1). Meanwhile, equity markets largely shook off the news, as investors’ attention remained squarely focused on this week’s earnings reports, including Nvidia and several large retailers. The S&P 500 briefly hit another all-time on Thursday, but retraced on Friday and looks to end the week slightly in the red.

Turning to the economic data calendar, the Bureau of Economic Analysis released its second estimate of Q2 real GDP. Relative to the first release, economic growth was revised higher by 0.3 percentage points to 3.3%. While net trade remained a major source of growth, a good chunk of the upward revision came from stronger business investment, specifically in categories that are likely tied to AI investments. In fact, spending on ‘computers & other peripheral equipment’ and ‘software’ accounted for all the growth in business investment through the first half of 2025.

Final sales to private domestic purchasers – the best gauge of underlying domestic demand – was raised from 1.2% to 1.9% and is now on-par with Q1’s rate of expansion. While this marks a deceleration from H2-2024 (Chart 2), it suggests the narrative of ongoing economic resilience hasn’t completely fizzled out amid ongoing trade uncertainty.

This point was further underscored in the Gross Domestic Income (GDI) figures, which accompany the second estimate of GDP and serve as an alternative measure of economic output. Real GDI rose a healthy 4.8% in Q2 – up from a flat reading in Q1. Corporate profits rose 7% annualized, despite elevated cost pressures from tariffs, while household income also continued to expand at a +5% clip.

Despite the healthy gains in income, households have become increasingly selective in their spending. Real PCE rose 0.3% month/month in July, with most of the gains coming from an increase in durable goods. Vehicle sales had a heavy hand in the uptick, as consumers appear to be pulling forward purchases to get ahead of tariff price increases which will likely materialize later this year once OEMs roll over to 2026 models. But it’s the discretionary services spending that remains weak, a theme that has played out through most of this year and something that’s unlikely to change until households have more certainty about the economic outlook.

With inflationary pressures heating up, this is unlikely to come anytime soon. Core PCE inflation rose 0.3% m/m, pushing the year-ago measures to 2.9% – a five-month high. Hotter services inflation was the major driver in last month’s uptick, something that is likely to further embolden Fed hawks. This puts next week’s employment report sharply in focus. Consensus currently expects payrolls to add 75k jobs in August. A stronger reading could push back on the odds for a September rate cut, which is currently 90% priced in.