The second quarter of 2026 has been defined by a familiar mix of resilient economic activity, persistent inflation concerns, elevated geopolitical risk, and capital markets that continue to defy expectations.
At the beginning of the quarter, consensus expectations called for modest growth, a slight cooling in the labor market, and gradual progress toward lower inflation. The Federal Reserve’s projections envisioned positive real GDP growth for 2026, with the unemployment rate near the mid-4 percent range, and inflation moving lower but remaining above the 2 percent target.
By mid-quarter, however, forecasts had become more cautious with economic growth revised lower, more muted job gains and significant uncertainty surrounding energy prices due to the conflict with Iran. Yet, by the end of the quarter, a bit more clarity emerged which resulted in solid gains in the capital markets.
The economic story remains one of moderation rather than contraction. Consumers continued to spend through elevated inflation, supported by labor income, transfer payments and asset growth. Yet, consumers are still facing increased pressures as uneven hiring trends and the rising cost of living erodes incomes and savings.
The surge in fuel prices and other materials, sparked by the conflict with Iran, is reverberating through the economy and has driven consumer sentiment to record lows. However, the latest job report was extremely strong, perhaps providing a ballast to the inflation and uncertainty facing consumers.
The data showed payrolls rose 172 thousand for the latest month with gains concentrated in hospitality, healthcare and government-related jobs. There were broad gains in the private sector along with manufacturing and service-related areas. Furthermore, the nation’s unemployment rate held steady at around 4.3 percent, well below the historical average.
Inflation remains the central complication for consumers, businesses and investors. Tariff-related price pressures, higher energy costs due to the conflict with Iran, and lingering affordability strains in housing, insurance, health care, and utilities have kept inflation above the Federal Reserve’s objective.
However, some cooling of inflation has started in certain service categories, but the progress remains uneven. Inflation as measured by the Consumer Price Index (CPI) jumped from 2.4 percent annually in January to 4.2 percent in May. Most of this increase was due to a surge in energy and commodity related prices due to the U.S. blockade of the Straits of Hormuz.
The somewhat fragile peace deal signed with Iran in late June has opened the door for the resumption of the flow of oil, which should lead to lower energy prices and perhaps an immediate reduction in headline inflation. This would be a welcome relief for all.
On the geopolitical front, while some progress has been made toward peace, other areas remain unresolved. The conflict with Iran appears headed toward a long-term resolution, but the Russia- Ukraine war remains unresolved. Although diplomatic activity continues and periodic discussions of ceasefire are encouraging, there has not yet been a durable settlement.
This ongoing conflict continues to influence Europe’s defense spending, energy security and fiscal policy. These pressures are likely to remain a structural feature of the investment landscape even if active hostilities eventually diminish. U.S.-China relations, meanwhile, continued to revolve around trade, technology, supply-chain resilience, and strategic competition. Markets have welcomed intermittent signs of diplomatic engagement, but the underlying rivalry remains intact.
During the quarter, returns in the capital markets reflected the divide between solid growth, positive corporate earnings and uncertainty surrounding inflation and geopolitical issues. For the quarter, the S&P 500 Index returned 15.2 percent, while mid cap and small cap U.S. equities delivered 14.5 percent and 19.7 percent, respectively. International equities, as represented by the MSCI All World Index, returned 13.9 percent. In fixed income, the Aggregate Bond Index returned 0.7 percent, and corporate bonds returned 1.4 percent.
Looking ahead, we continue to believe the most likely outcome is modest growth, inflation that gradually declines, and a Federal Reserve that eventually gains enough confidence to begin an easing policy. While the margin for error may be slim, corporate earnings are growing at a hefty pace, the unemployment rate remains low, and consumer spending is positive. These are all good signs for continued positive returns in the capital markets, despite elevated valuations.