Our August economic analysis: Cautious optimism and nervous anticipation

August was a relatively calm month with less noise around tariff issues. Equity markets continued to climb to all-time highs on hopes of a pending easing cycle from the Federal Open Market Committee (FOMC)‡.

Inflation data delivered some harsh surprises during the month, heating up the debate about what is headed our way over the coming months. In particular, Producer Prices (the PPI Index)‡ showed up dramatically higher than anticipated, causing some resurgence of concerns that tariffs may be starting to drive domestic inflation higher.

The FOMC conducted its annual summer meeting in Jackson Hole, Wyoming, and Chairman Powell concluded the event with commentary that gave the markets a strong injection of optimism. He acknowledged that inflation is elevated and that tariffs may push it higher but indicated the Fed is focusing more on below-average economic activity and a softening labor market.

Real wages and consumption are holding up surprisingly well still, but these will depend entirely on the trends in the labor market. Early in August, the July payroll data were meaningfully below expectations, and previous months’ results were revised significantly lower. The year-to-date payroll growth is significantly below what is required for a stable unemployment rate, indicating that meaningfully softer labor conditions could be headed our way. Chairman Powell made a dovish shift by conveying that the labor market data is more concerning to them than inflation.

Chairman Powell’s comments were interpreted as a clear indicator that the Fed is ready to cut rates further at the next meeting, which takes place this month. The stock market staged a powerful rally after his comments and continued to climb into month-end, closing August at a new all-time high. The S&P 500 has returned nearly 10% thus far in 2025.

A challenging side note

Late in the month, another round of controversy regarding the FOMC emerged. One of the committee members was fired by President Donald Trump for falsifying information on a mortgage application. Hints about the termination of Chairman Powell have also been circulating for several months. The legitimacy of the president’s power to terminate FOMC members is hotly debated, and the issue has dramatically increased uncertainty around the independence of the FOMC.

Everyone is entitled to their opinion about this subject – but the uncertainty could keep treasury rates elevated, even as the Fed executes further cuts to overnight rates. Lack of confidence about FOMC independence, when combined with ongoing budget deficits, could cause investors to demand more yield from longer-term treasury bonds, therefore preventing longer rates from falling in tandem with cuts to the overnight rate.

We commented last month that we expected the Fed might be able to look past the inflation issues, focusing on softening economic fundamentals to rationalize further cuts to overnight rates. Our official forecast has two rate cuts in 2025 (September and December) and two or three more in 2026. This would help bolster confidence heading into next year and should help push GDP back up to a more normal range around 2%. This should help keep consumption and earnings pushing higher in 2026. As uncertainty around inflation and rates begins to subside, we could also benefit from increased CapEx in the commercial/industrial space – which bolsters activity, jobs and the overall economy.

We are growing more optimistic but are still cautious about the potential impacts of unprecedented tariff regimes. The current narrative indicates that the tariff burden will be shared equally by exporters, importers and consumers – ultimately not causing any major turbulence. We are hopeful that this will come to pass, but wish to see a few more months’ data before we consider moving into a more bullish mindset.

In summary

Market resilience in 2025 continues to surprise to the upside. The U.S. economy is running below normal, and there are still signs of stress in the system, particularly in the labor market. The new tariffs will be coming online over the coming months, and the ultimate impact is uncertain. The equity markets are clearly reflecting an assumption that tariff damage will be minimal and that the Fed will lower rates enough to reignite GDP growth heading into 2026.

We are becoming more optimistic that we could be back on a strong economic trajectory as we move into 2026, but we remain cautious at this time because there are multiple risks to the economy and lofty valuations in the equity markets. We continue to remain neutral in our risk allocation, believing that the time for heavier risk exposure has yet to present itself.

We are here to provide our clients with peace of mind about their financial future.  Anchoring to a sound, long-term financial plan will help everyone weather storms like these. We will remain disciplined and consistent in our strategies and philosophies. We are confident that together we will manage our way through this (hopefully brief) challenging time.

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Disclosures and Important Considerations

UMB Investment Management and UMB Private Wealth Management are divisions within UMB Bank, n.a. (a subsidiary of UMB Financial Corporation) that manage active portfolios for employee benefit plans, endowments and foundations, fiduciary accounts and individuals. UMB Financial Services, Inc., Member FINRA, SIPC, offers broker/dealer and investment advisory services to retail and institutional investors and is also a subsidiary of UMB Financial Corporation and is an affiliate of UMB Bank.

Note that “we” and “our” used throughout this letter refers to UMB Investment Management’s thoughts and expectations.

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