The iconic mantra from the science-fiction universe Dune serves as a stark reminder of the importance of critical resources and the far-reaching implications when supply chains are disrupted. This theme played out in real time during 2Q26 as oil continued to flow, but concerns around the Strait of Hormuz, a key bottleneck for global energy markets, served as one of the primary drivers of geopolitical uncertainty and market volatility. Brent crude briefly exceeded $120 per barrel before reversing course and ending the quarter near $73 as supply concerns eased.

Despite the uncertainty, U.S. economic growth and corporate earnings remained resilient, helping equity markets recover losses from the prior quarter and reach new highs. Meanwhile, science fiction continued to mirror reality as investors remained focused on the sustainability of artificial intelligence-related capital spending, balancing optimism around technological advancement with questions surrounding valuations.

Beyond market narratives, economic data presented a more complicated backdrop. Inflation concerns remained elevated following hotter-than-expected readings and the impact of higher energy prices, coinciding with Treasury yields moving up during the quarter. The Federal Reserve, under new Chairman Kevin Warsh, faced a shifting macroeconomic environment as policymakers balanced renewed inflation pressures against signs of cooling in the labor market and uneven economic growth.

Highlights of the Economy in 2Q26

The Federal Open Market Committee (FOMC) voted in June to keep the Federal Funds Rate unchanged at 3.50% – 3.75% during Warsh’s first meeting as chairman. The updated Summary of Economic Projections reflected a shift toward a more restrictive policy outlook, with the median projection for the Fed Funds Rate increasing to 3.8% by year-end 2026, up from 3.4% in March. Meeting participants remained divided on the path forward, with eight expecting no change, nine projecting at least one rate increase, and one expecting a rate cut. Inflation projections also moved higher, with the median estimate jumping to 3.6% from 2.7% in March, reflecting renewed price pressures following the energy shock. The FOMC statement emphasized that inflation remains above the committee’s 2% objective, driven in part by supply-related pressures across certain sectors, including energy.

Following the meeting, Warsh confirmed he abstained from making a projection, highlighting he does not think it is helpful in the conduct of policy, and signaled potential changes to the Fed’s communication strategy and use of forward guidance. By quarter-end, markets were pricing in a high likelihood of a rate hike by the end of the year.

Inflation pressures accelerated during the quarter as higher energy prices added to already elevated price pressures. Headline Personal Consumption Expenditures (PCE) inflation reached a seasonally adjusted 4.1% annual rate in May, while Core PCE rose to 3.4%, its highest level since October 2023. The increase in the headline figure reflected higher energy costs tied to the Iran War, along with continued pressure across certain goods and services categories. Similarly, the Consumer Price Index for All Urban Consumers (CPI-U) rose 4.2% year-over-year in May, up from 3.8% in April, while Core CPI increased 2.9%. According to the Philadelphia Fed’s Survey of Professional Forecasters, expectations for near-term inflation increased sharply, though inflation is projected to moderate later in the year while remaining above the Fed’s 2% target.

The labor market showed signs of cooling as nonfarm payroll growth slowed during the quarter. Employers added 57,000 jobs in June, below expectations and down from May’s revised gain of 129,000. Health care and social assistance continued to drive job creation, while information technology employment declined, highlighting the divergence between AI-related capital spending and employment trends in the sector. Although the unemployment rate declined to 4.2%, the improvement was partially driven by a decline in the labor force participation rate, which potentially reflected changes in labor supply, including demographic trends and shifting immigration. Additional signs of labor market softening emerged as the share of long-term unemployed workers, those without a job for 27 weeks or longer, rose to 27% from 25% in April.

The revised GDP figure for 1Q26 depicted an economy that remained resilient, supported in part by strong AI-related capital spending. GDP grew at a seasonally adjusted annualized rate of 2.1%, according to the final estimate, with the upward revision from 1.6% primarily driven by a smaller drag from the trade deficit and stronger business investment. Below the headline figure, economic activity was somewhat uneven. Consumer spending slowed to a 0.5% pace from the previously reported 1.4%, reflecting downward revisions to services spending, including financial services, insurance, and international travel. Meanwhile, business investment remained a bright spot, with equipment spending increasing at a 15.8% annualized rate and intellectual property investment rising 13.8%. Spending on data centers and other AI infrastructure by four large technology companies is expected to exceed $670 billion this year.

Forward-looking indicators pointed to a more uneven growth backdrop. Activity in the manufacturing sector expanded for the fifth consecutive month, with the ISM Manufacturing PMI registering 54.0, its highest reading since May 2022, supported by improvement across several underlying components. However, interest-rate sensitive areas of the economy remained under pressure. Housing activity weakened as starts and building permits declined more than expected in May and fell below year-ago levels. The Atlanta Fed’s GDPNow estimate for 2Q real GDP growth was revised lower to 1.2% from 2.5%, primarily reflecting weaker assumptions for net exports and private domestic investment.

Global Macroeconomics

The euro zone economy showed signs of stabilization by the end of the quarter. First quarter GDP was revised down to a 0.2% contraction from the previously reported 0.1% expansion, marking the region’s first contraction since late 2022. The decline was primarily driven by weaker output in Ireland and France. More recent data pointed to modest improvement, with the S&P Global Eurozone Composite PMI Output Index rising to 50.0 in June after two months in contractionary territory. Manufacturing production improved and offset continued weakness in services activity. However, the growth outlook remained subdued, with the Organization for Economic Cooperation and Development (OECD) projecting euro zone GDP growth of 0.8% in 2026, down from 1.4% in 2025.

The European Central Bank (ECB) raised its key interest rate in June for the first time in three years by 25 basis points to 2.25%. The ECB cited renewed inflation pressures stemming from the conflict in the Middle East and emphasized its commitment to returning inflation sustainably to its 2% medium-term target. The EU’s flash estimate for annual inflation declined to 2.8% in June from 3.2% in May, while core inflation moderated to 2.4% from 2.6%. Among the major economies, inflation slowed in Germany (2.4%), France (2.0%), and Italy (3.1%), but remained unchanged in Spain (3.6%), highlighting divergence across the region.

Across Asia, AI-related demand continued to support technology supply chains and capital investment. South Korea’s economy exceeded expectations in 1Q, expanding at a 3.6% annualized rate, its fastest pace since 2020, supported by stronger exports. Export momentum continued into 2Q, driven by semiconductor demand tied to artificial intelligence infrastructure. Chip exports reached a record $45 billion, underscoring the scale of demand from AI-related investment. The Bank of Korea maintained its key policy rate at 2.5% in May, though rising inflation increased pressure for a potentially more restrictive policy stance.

Japan’s economy expanded at an annualized rate of 1.8% in 1Q, a slight revision lower from the preliminary estimate. Policymakers continued to support strategic industries, including an approximately $8 billion government allocation toward AI and semiconductor development. Meanwhile, the Bank of Japan continued its gradual policy normalization process, raising its policy rate by 25 bps to 1.00% in June.

China’s real GDP grew 5.0% year-over-year in 1Q, up from 4.5% in 4Q25, supported by resilient exports, high-tech manufacturing, and targeted investment. However, 2Q data pointed to an uneven recovery as industrial output slowed and retail sales growth weakened to its lowest level in three years. The slowdown in consumption was partially attributed to government subsidy programs that boosted sales last year, potentially pulling forward household purchases that otherwise would have occurred this year. Policymakers continued to signal support measures aimed at stabilizing domestic demand.

Closing Thoughts

The second quarter served as another reminder that markets are shaped by both unexpected disruptions and periods of transformation. While uncertainty remains elevated, we continue to encourage investors to maintain a long-term perspective and a prudent, well-diversified asset allocation.