The latest data releases have reinforced the choppiness that’s characterized the U.S. economy for some time. February’s labor data along with previous months’ revisions show a mixed-to-weaker labor market that certainly won’t make the Federal Reserve’s (Fed’s) decisions over the coming meetings any easier. Add to that the Iran war and accompanying risks to energy prices, the global economy, and inflation, and the picture has gotten even more complex.
U.S. payrolls dropped 92,000 in February, badly missing the consensus expectation for a gain of 60,000. Downward revisions carved off another 69,000 from the January and December tallies, pulling the six-month average down to -1,000. While February’s numbers were impacted by a healthcare strike and massive winter storms, evidence of the “low hire/low fire” environment is strong. The unemployment rate rose to 4.4% leaving it above the 4.0% pre-pandemic level. On a positive note, average hourly earnings rose 0.4% month over month and wages for rank & file workers rose 0.3% over the month. Both are well above their respective growth rates pre-pandemic.
While we aren’t overly concerned, the direction of inflation has clearly shifted and is no longer grinding lower. Our 2026 outlook anticipated that inflation would remain stickier, and indeed inflation has risen on both the consumer and wholesale fronts in recent months. The Iranian conflict threatens to inflame inflationary pressures. Crude prices that are set on global markets jumped 40% immediately after the start of the conflict. While the U.S. is somewhat insulated from the price and supply shocks since 90% of our crude oil comes from North America, there could be more pain ahead, even if the conflict is resolved relatively quickly (our base case).
If the inflation trend persists or accelerates, it will pose a rather large hurdle for the Fed to lower interest rates later this spring. At the very least, it would push rate cuts further back in the year. In a worst-case scenario, it could avoid rate cuts altogether in 2026. However, it’s premature to make that leap based on the current trend. Given the near-term uptick in inflation (and the risk for more), even with labor market weakness, we expect the Fed to stay on hold in the near term and maintain our view for a summer rate cut.
On the positive side, personal tax refunds are running more than 10% above last year, which should help bolster consumers. That’s after just three weeks of tax returns; we anticipate refunds should at least triple in the next month—a key economic catalyst for our 2026 outlook.
Bottom line
We’ve described the U.S. economy as feeling like it has one foot on the gas (fiscal and monetary stimulus) and one foot on the brake (trade and tariff uncertainty, underwhelming job growth), reflecting the persistent “low hire/low fire” environment. This muddled backdrop is likely to keep the Fed in a holding pattern in the near term after last year’s pre-emptive rate cuts.
