August began with a bang as concerns about expensive stock valuations—particularly in the surging information technology sector—and rising interest rates in Japan were amplified by weak employment data and fears that the U.S. Federal Reserve (Fed) could be significantly behind the curve and need to cut interest rates aggressively.

But the panic proved short lived. As the month unfolded, economic data revealed a more resilient economy and declining inflation. By and large, investors came back to the view that the U.S. economy would achieve a soft landing and the Fed would likely cut interest rates modestly and in accordance with the data.

July’s retail sales rose more than expected, jobless claims fell and second quarter gross domestic product (GDP) was revised higher (from 2.8% to 3.0%), with personal spending—a key engine for economic growth—revised up to 2.9% from 2.3%.

Inflation data was also supportive. July’s Consumer Price Index (CPI) rose 2.9%, 0.1% less than expected and the lowest level since 2021. Also, the rise in Core CPI (excluding the more volatile food and energy sectors) was lower for the third consecutive month, providing some confidence that its trend toward the Fed’s target rate remained intact. Finally, the Core Personal Consumption Expenditures (PCE) Price Index—the Fed’s preferred measure of inflation—was stable at 2.6% year-over-year for the third consecutive month, beating expectations for a 2.7% rise. 

From Jackson Hole, Wyoming, Fed Chairman Jerome Powell grounded market expectations near month end. “The time has come for policy to adjust,” he said, adding that his “confidence has grown that inflation is on a sustainable path back to 2%.” Markets took that to mean a September rate cut should be assumed. While economic data, particularly employment data, would likely drive the pace of the imminent easing cycle, the days of speculating about when the cycle would begin were over. By month end, both the S&P 500^® Index and the Dow Jones Industrial Average generated their fourth consecutive monthly rise, and benchmark 10-year Treasury yields were below 4%.

Outlook: The volatility we saw in early August was extreme, but we have long cautioned that economic turning points can be volatile and market shocks typically come as a surprise. As the turning point is still in its early phase, we continue to recommended investors maintain a more cautious positioning, favoring high-quality assets in both stocks and bonds.

August’s economic and inflation data, on balance, supported our base-case scenario that the U.S. economy will achieve a soft landing and the Fed will maintain a slow, but steady pace of interest rate cuts in the quarters ahead. But, we continue to believe that the mixed economic data, the potential for surprises, uncertainty about the path of interest rates and concerns about geopolitical risks all continue to warrant caution.

There are signs that a broader weakening of the economy could still unfold, likely driven by a deterioration in the labor market. Unemployment has risen, job openings have fallen, wage growth has been slowing and the aggregate consumer is saving less. The ability of the consumer to fuel economic growth should not be assumed, however optimistic we may be. Meanwhile, tensions continue to rise in the Middle East, Ukraine invaded Russia and uncertainty about the outcome and implications of the U.S. presidential election are likely to rise as we get closer to November 5.  

Despite these risks, we continue to believe investors are better served by focusing on the long-term fundamental outlook, by staying invested in the market and maintaining a roughly neutral position in terms of risk tolerance—that is, being neither significantly under or overweight in either stocks or bonds. While we expect equities to remain supported into year end, we expect U.S. Treasury bonds to serve as a counterbalance to equity exposure, with additional macroeconomic or stock market weakness likely to drive interest rates lower and bond prices higher. Finally, we believe in active management of investment portfolios, and recommend increasing or decreasing risk on the margin as the outlook evolves and potential opportunities arise.