The second quarter was shaped by geopolitical tensions, evolving Fed leadership, and continued enthusiasm for artificial intelligence, all against a backdrop of resilient economic growth.
Taken together, the quarter reinforced a familiar theme: economic growth remains durable, but inflation, elevated interest rates, and geopolitical uncertainty continue to shape the investment landscape.
The second quarter was defined by a shifting set of market narratives. Geopolitical tensions in the Middle East and volatile energy prices captured investor attention, while enthusiasm for artificial intelligence continued to drive equity markets to record highs. Meanwhile, inflation reemerged as the market's primary concern, eclipsing fears of a slowing labor market. Against this backdrop, newly appointed Federal Reserve Chair Kevin Warsh began his tenure with a distinctly hawkish message, reinforcing the central bank's commitment to price stability.
Despite these challenges, the U.S. economy remained remarkably resilient. Consumer spending continued to support growth, though the experience across households was far from uniform. Rising energy costs and persistent inflation disproportionately affected lower-income consumers, while higher-income households remained relatively insulated. As a result, the quarter underscored both the durability of the expansion and the uneven nature of its benefits.
The U.S. economy entered the second quarter with more momentum than many anticipated. Final first-quarter GDP growth was revised to a solid 2.1%, a notable improvement from the 0.5% pace recorded in the fourth quarter of 2025. Looking ahead, second-quarter growth estimates generally range between 2.0% and 2.5%, though real-time tracking measures point to somewhat more modest expansion.
Business investment, government spending, exports, and consumer spending all contributed to first-quarter growth. Net exports remained a drag, as imports once again outpaced exports. While often viewed negatively, stronger imports can also reflect healthy domestic demand, as GDP is designed to measure domestic production rather than total spending.
As is often the case, the most important contributor to growth was the American consumer. Personal consumption accounts for roughly 70% of economic activity, making household spending the primary engine of the U.S. economy. Consumer demand has remained remarkably resilient despite higher interest rates, persistent inflation, and periodic market volatility.
The sustainability of the expansion ultimately rests on the health of the consumer. While spending patterns remain constructive today, any meaningful weakening in household demand would likely have broad implications for economic growth. For now, however, the consumer continues to provide a firm foundation for the economy and remains the key reason recession fears have yet to materialize.
Few stories commanded investors' attention during the second quarter more than the conflict between the United States and Iran. For much of the quarter, oil prices became the market's preferred barometer of geopolitical risk, with each new development prompting swift reactions across global financial markets.
At the center of those concerns was the Strait of Hormuz, one of the world's most important energy chokepoints. Roughly one-fifth of global oil supplies move through the narrow passage, making any disruption a significant threat to global energy markets. Investors closely monitored developments as concerns grew that military escalation could impair the flow of crude oil from the Middle East.
In the early stages of the conflict, markets focused intensely on headlines rather than fundamentals. Reports of increased tensions sent oil prices sharply higher, while signs of diplomacy or potential ceasefires quickly reversed those gains. As the quarter progressed, however, investors became less reactive to rhetoric and more focused on tangible developments that either increased or reduced the probability of a broader regional conflict.
Ultimately, fears of a sustained energy shock proved short-lived. As de-escalation efforts gained traction, crude oil prices retreated to roughly $70 per barrel after briefly surging to nearly $126. While the volatility created challenges for consumers and businesses alike, the U.S. economy proved more resilient than many global counterparts. America's relatively strong domestic energy production helped cushion the impact of higher oil prices, limiting the economic fallout compared with regions that remain more dependent on Middle Eastern energy supplies.
Although consumers felt the effects through higher gasoline prices and transportation costs, the quarter ultimately served as a reminder that while geopolitical events can create sharp market disruptions, their economic impact often depends on how long they persist. In this case, the oil shock generated considerable volatility but relatively limited lasting damage.
The June FOMC meeting marked the official beginning of the Kevin Warsh era at the Federal Reserve. While the Committee's decision was widely expected - holding the Federal Funds rate unchanged at 3.50%-3.75% - the meeting suggested that the leadership transition may bring meaningful changes to both policy and communication.
Despite easing oil prices, inflation remained elevated enough to keep policymakers focused on price stability. Any language that hinted at a bias toward future rate cuts disappeared from the Committee's statement, while discussions of potential tightening gained greater prominence. Chair Warsh reinforced that message in his inaugural press conference, adopting a distinctly hawkish tone and emphasizing the Fed's commitment to returning inflation closer to its 2% target.
Beyond monetary policy, Warsh used the opportunity to outline several institutional reforms. Most notably, he chose not to submit an individual forecast to the Summary of Economic Projections, signaling skepticism toward the Fed's well-known "dot plot." He also announced a series of internal review initiatives (task forces) aimed at evaluating policy processes and organizational practices. Additionally, he indicated a desire to reduce the Fed's reliance on forward guidance, arguing that policymakers should retain greater flexibility and react to incoming data rather than pre-commit to future actions.
My initial assessment is mixed. Warsh deserves credit for recognizing that the Fed may have become overly communicative in recent years. Markets often receive more guidance than clarity, and a more disciplined communication strategy could help restore focus on economic fundamentals rather than parsing every word from policymakers.
That said, there is a fine line between reducing unnecessary commentary and reducing transparency. Investors still need to understand how the Fed interprets inflation, employment, and financial conditions. Striking that balance will be one of the defining challenges of Warsh's tenure.
As for the newly announced task forces, I remain skeptical. While reviews and committees can be useful, they often produce more process than progress. Investors would likely benefit more from a clearer policy framework than from another round of internal studies. For now, the most important takeaway is that the Fed has a new leader, a more hawkish tone, and a renewed emphasis on inflation - changes that could have significant implications for markets in the quarters ahead.
For investors hoping inflation would continue its steady march lower, the second quarter offered little encouragement. While oil prices retreated from their wartime highs, the broader inflation picture remained stubbornly unfavorable. Higher energy costs earlier in the quarter, combined with ongoing tariffs and persistent service-sector price pressures, continued to weigh on consumer prices.
More concerning for policymakers, the key measures of core inflation, which exclude the more volatile food and energy categories, moved higher throughout the quarter. Several inflation gauges approached multi-year highs, reinforcing concerns that underlying price pressures remain deeply embedded in the economy rather than simply reflecting temporary shocks.
The persistence of inflation has forced markets to reassess earlier expectations for a more accommodative Federal Reserve. Despite hopes that slowing labor market conditions would shift the Fed's focus toward supporting employment, inflation has once again become the dominant concern. As a result, the balance of the Fed's dual mandate has tilted decisively toward price stability.
For now, the long-anticipated "last mile" of the inflation fight continues to be the most difficult. Progress has slowed, inflation remains above target, and policymakers appear increasingly willing to tolerate some economic softness in pursuit of restoring price stability. For investors, the message is clear: the battle against inflation is proving longer and more challenging than many expected.
Despite persistent concerns that a weaker labor market could undermine economic growth, employment conditions remained remarkably resilient throughout the quarter. Rather than deteriorating, the labor market appears to be gradually settling into a more sustainable post-pandemic equilibrium.
Employers remain reluctant to add workers aggressively, but they are equally hesitant to reduce headcount. As a result, the "low-hire, low-fire" dynamic that has characterized much of the past year remains firmly in place. Workers are staying employed, voluntary turnover remains subdued, and layoffs have remained modest by historical standards.
Nonfarm Payrolls data illustrate this transition clearly. Job creation has slowed considerably from the extraordinary hiring surge that followed the pandemic, with recent gains frequently falling below historical norms. While several months of weak, or even negative, payroll growth would typically raise recession concerns, investors have become more accepting of a slower pace of hiring as the labor market adjusts to a new normal. Recent job gains averaging between 50,000 and 100,000 per month suggest moderation, not contraction.
Equally important, the unemployment rate continues to send a reassuring signal. After peaking at 4.5% in late 2025, unemployment gradually moved lower and remains within the range generally associated with full employment. Stable unemployment, combined with limited hiring and limited layoffs, suggests a labor market that is somewhere between cooling and weakening.
Taken together, the data point to a labor market that is no longer booming but remains fundamentally healthy. Hiring has slowed, yet employment remains stable—an outcome consistent with an economy that is moderating rather than moving toward recession. For now, the labor market remains a source of stability rather than a cause for concern.
The housing market's biggest challenge remains unchanged: affordability. Elevated mortgage rates and home prices continue to pressure prospective buyers, particularly first-time homeowners. At the same time, millions of existing homeowners remain locked into mortgages originated at historically low interest rates, reducing both the incentive to sell and the supply of available homes.
As with most discussions surrounding real estate, location matters. While national home price appreciation has slowed considerably, local market conditions vary widely. Some regions are experiencing improving inventory levels and softer demand, while others continue to face supply shortages that support higher prices. Although the pace of price growth has moderated, housing costs remain well above levels that would restore affordability for many households.
The impact of these conditions is evident in existing home sales, which have remained largely stagnant for several years. Annual sales have hovered near 4 million units since the pandemic-driven housing boom subsided, well below the roughly 5.3 million annual pace that prevailed during the decade preceding COVID. Higher mortgage rates, elevated home prices, limited inventory, and a labor market characterized by low job mobility have combined to keep many buyers and sellers on the sidelines.
For now, the housing market remains trapped in a state of gridlock. Existing homeowners are reluctant to give up favorable mortgage terms, while prospective buyers struggle to make the economics work. Meaningful improvement in affordability will likely require either lower mortgage rates, lower home prices, higher household incomes, or some combination of all three. Until then, housing activity is likely to remain subdued relative to historical norms.
One of the more encouraging developments this quarter was evidence that the divide between higher- and lower-income households may be starting to narrow. For much of the post-pandemic period, economic growth was disproportionately driven by affluent consumers, whose spending power and balance sheets remained exceptionally strong. Recent data suggest that dynamics may be beginning to change.
Consumer spending increased across all income groups during the quarter, reflecting both higher prices and continued demand. Rising gasoline expenditures were largely driven by higher fuel prices rather than increased consumption. More notably, spending on retail goods continued to trend higher, highlighting healthy demand and providing further support for overall economic growth.
Recent credit and debit card data reveal that spending increased across all income cohorts. While higher-income households continue to account for the largest share of consumer spending, growth in spending among middle- and lower-income households outpaced that of their wealthier counterparts. At the same time, gains in after-tax wages and salaries have begun to improve for these groups, helping narrow some of the income gap that had widened during the recovery.
This shift matters because the economy's recent growth has leaned heavily on the spending power of higher-income consumers. A broader participation rate across income levels would make the expansion more balanced and potentially more durable. Even if overall GDP growth remains in the 2.0% to 2.5% range, growth supported by a wider portion of the population is generally healthier than growth concentrated among a relatively small segment of consumers.
While it is too early to declare the end of the K-shaped economy, recent trends suggest the gap may finally begin to close. If wage growth among middle- and lower-income households continues to improve, the economy could benefit from a broader and more sustainable foundation for future growth.
After a volatile start to the quarter driven by the outbreak of conflict with Iran, equity markets staged an impressive recovery. As geopolitical fears subsided and investor confidence returned, major indices surged higher. The Dow Jones Industrial Average, S&P 500, and Russell 2000 delivered returns of approximately 13%, 15%, and 21%, respectively, during the quarter.
Several factors fueled the rebound. Easing tensions in the Middle East helped moderate energy prices and alleviated concerns about corporate profit margins. At the same time, corporate earnings remained strong, with companies continuing to exceed expectations and analysts raising forward earnings forecasts. The combination of resilient economic growth and healthy corporate fundamentals provided a supportive backdrop for equities.
The dominant market theme remained artificial intelligence. After brief concerns that technology companies were overspending on AI-related infrastructure, investors regained confidence that these investments would drive future growth and productivity. As a result, AI-related stocks once again led market performance. Semiconductor manufacturers, memory-chip producers, data center operators, and other "picks-and-shovels" beneficiaries of the AI buildout were among the strongest performers of the quarter.
Heading into 2026, expectations called for a moderation in returns following several years of exceptional gains. That outlook remains intact, but the market's strong first-half performance has brought annual return expectations within reach much earlier than anticipated. My year-end S&P 500 target of 7,700—equivalent to approximately a 10% annual return—appears increasingly attainable if earnings growth remains supportive.
That said, markets rarely move in a straight line. Following the sharp advance through the second quarter, a period of consolidation or modest pullback would not be surprising. Such volatility would be consistent with historical seasonal patterns and could ultimately provide investors with a more attractive entry point. While near-term fluctuations are inevitable, the combination of strong earnings, resilient economic growth, and continued investment in AI infrastructure suggests the broader backdrop for equities remains constructive as we move into the second half of the year.
Interest rates spent much of the second quarter reacting to the same forces driving broader financial markets: geopolitical uncertainty, energy prices, and inflation expectations. Treasury yields moved sharply higher early in the quarter as the conflict with Iran fueled concerns that rising oil prices would reignite inflationary pressures. As tensions eased and oil prices retreated, rates gave back a portion of those gains but remained above their pre-conflict levels.
While investors became less concerned about an immediate energy-driven inflation shock, the broader inflation outlook remained stubbornly uncertain. Elevated energy costs earlier in the quarter, ongoing geopolitical risks, and persistent underlying inflation pressures continue to complicate the path toward lower interest rates.
One notable development was the continued flattening of the yield curve. Shorter-term Treasury yields moved higher than longer-dated maturities as markets adjusted to a Federal Reserve that appears increasingly focused on inflation rather than economic slowing. Despite public calls for lower interest rates, the Fed entered the second half of the year with a more hawkish bias and little urgency to ease policy.
As a result, 2-year Treasury yields remain firmly above 4%, reflecting expectations that policy rates are likely to stay elevated for longer than many investors had anticipated. At the same time, the 10-year Treasury finished the quarter near the important 4.5% threshold - a level that carries implications far beyond the bond market. Because the 10-year Treasury serves as the foundation for equity valuation models, higher yields increase the hurdle rate for stocks and place pressure on valuation multiples. The 10-year rate also serves as a key benchmark for mortgage pricing, influencing housing affordability and broader economic activity.
Meanwhile, long-term Treasury yields continue to reflect concerns that extend beyond near-term monetary policy. Thirty-year bonds maintain a sizable premium over shorter maturities as investors demand additional compensation for inflation risk, heavy Treasury issuance, and growing federal deficits. The long end of the market has also lost two important sources of demand: the Federal Reserve, which is no longer a significant buyer following the end of quantitative easing, and foreign central banks, whose Treasury purchases have moderated in recent years.
The result is a bond market that increasingly reflects structural forces rather than simply Fed policy. While short-term rates remain tied to the inflation outlook, long-term yields continue to price in concerns about deficits, debt issuance, and the long-run cost of capital. For investors, the message remains clear: rates may eventually move lower, but the era of exceptionally low interest rates appears firmly behind us.
As we enter the second half of 2026, the economic outlook remains constructive despite a series of challenges that tested both markets and consumers during the first half of the year. The economy weathered geopolitical turmoil, elevated energy prices, persistent inflation, and shifting monetary policy expectations without experiencing a meaningful deterioration in growth. While I have modestly reduced my GDP outlook, I continue to expect real economic growth in the 2.0% range, a pace consistent with a mature but expanding economy.
My base case remains a soft landing. Economic growth is slowing from the unsustainably strong pace of the post-pandemic recovery, but there is little evidence of an imminent recession. Inflation remains elevated, and the labor market continues to cool, but neither appears severe enough to derail the expansion. While unforeseen events can always alter the outlook, recession and stagflation risks remain low in my view.
The Federal Reserve enters this next phase under new leadership, and investors will need time to adjust to Chair Warsh's evolving policy framework. A less prescriptive communication strategy may result in greater market volatility, but if paired with sufficient transparency, it could ultimately improve policy flexibility and decision-making. Given the persistence of inflation, my expectation remains that policy is not yet restrictive enough, leaving the door open for at least one additional rate hike before year-end.
Interest rates are therefore likely to remain elevated. Inflation pressures and fiscal concerns continue to support a higher-for-longer environment, and I see little reason to expect a sustained decline in long-term Treasury yields. As a result, borrowing costs are likely to remain a headwind for interest-rate-sensitive sectors, particularly housing, where affordability challenges show few signs of meaningful improvement.
Equities have already achieved a substantial portion of my full-year return expectations, yet the fundamental backdrop remains supportive. Strong corporate earnings, resilient economic growth, and continued investment in artificial intelligence should provide ongoing support for risk assets. While a seasonal pullback or period of consolidation would not be surprising, such volatility would likely create opportunities rather than alter the long-term outlook.
Investors should remain mindful of potential risks. Geopolitical tensions, trade policy uncertainty, and unexpected economic shocks have repeatedly tested markets over the past 18 months. Those risks are unlikely to disappear. However, recent experience has shown that periods of uncertainty often create attractive entry points for disciplined investors.
The road ahead will almost certainly include bouts of volatility. But with economic growth continuing, corporate fundamentals remaining healthy, and innovation driving investment, the balance of evidence supports maintaining a constructive outlook for both the economy and financial markets as we move through the remainder of 2026.
An index is unmanaged and not available for direct investment. Definitions sourced from Bloomberg.
The Bloomberg Barclays Global Aggregate Negative Yielding Debt Market Value Index represents the portion of the Bloomberg Barclays Global Aggregate Index that measures the aggregate value of global debt with a negative yield. • The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. • The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.• The Cboe Volatility Index® (VIX) is a calculation designed to produce a measure of constant, 30-day expected volatility of the US stock market, derived from real-time, mid-quote prices of weekly S&P 500® Index (SPX) call and put options with a range of 23 to 37 days to expiration.• The ICE BofA MOVE Index is a yield curve weighted index of the normalized implied volatility on 1-month Treasury options. It is the weighted average of implied volatilities on the CT2 (Current 2 Year Government Note), CT5 (Current 5 Year Government Note), CT10 (Current 10 Year Government Note), and CT30 (Current 30 Year Government Note), with weights 0.2/0.2/0.4/0.2 respectively.• The Markit CDX North America Investment Grade Index is composed of 125 equally weighted credit default swaps on investment grade entities, distributed among 6 sub-indices: High Volatility, Consumer, Energy, Financial, Industrial, and Technology, Media & Tele-communications. Markit CDX indices roll every 6 months in March & September. • The Markit CDX North America High Yield Index is composed of 100 non-investment grade entities, distributed among 2 sub-indices: B, BB. All entities are domiciled in North America. Markit CDX indices roll every 6 months in March & September. • The U.S. Dollar Index (USDX) indicates the general international value of the USD. The USDX does this by averaging the exchange rates between the USD and major world currencies. Intercontinental Exchange (ICE) US computes this by using the rates supplied by some 500 banks.
Investing involves certain risks, including possible loss of principal. You should understand and carefully consider a strategy’s objectives, risks, fees, expenses, and other information before investing. The views expressed in this commentary are subject to change and are not intended to be a recommendation or investment advice. Such views do not take into account the individual financial circumstances or objectives of any investor that receives them. All indices are unmanaged and are not available for direct investment. Indices do not incur costs including the payment of transaction costs, fees, and other expenses. This information should not be considered a solicitation or an offer to provide any service in any jurisdiction where it would be unlawful to do so under the laws of that jurisdiction. Past performance is no guarantee of future results.
© 2025 SWBC. All rights reserved. Securities offered through SWBC Investment Services, LLC, a registered broker/dealer. Member FINRA & SIPC. Advisory services offered through SWBC Investment Company, a Registered Investment Advisor, registered as such with the US Securities & Exchange Commission. SWBC Investment Services, LLC is under separate ownership from any other named entity. SWBC Investment Services, LLC a division of SWBC, is a nationwide partnership of advisor.