This month I’d like to update our outlook for inflation, the Federal Reserve, and GDP—and touch on an interesting theme within GDP’s components.

Then I’ll tie it all together and discuss how it’s affecting our market outlook.

That’s a lot to cover, and I’m not one for long introductions, so let’s get right into it.

GDP

First, looking at GDP projections, the Atlanta Federal Reserve estimates that real (inflation-adjusted) GDP for the third quarter currently is 3.9%.

As I’ve mentioned previously, I don’t always find the Atlanta Fed’s real GDPNow growth rate to be accurate, but directionally (positive or negative) it’s typically accurate.

There was a fair amount of concern about growth in the first half of this year, which saw an annualized decrease of 0.6% in the first quarter.

Since then, however, there was an annualized increase of 3.8% in the second quarter, and the projection for the third quarter is, as I mentioned, an annualized increase of 3.9%.

This is a positive sign for economic growth:

What’s more interesting is the contribution by components so far this year.

As we can see in the next chart (left-hand side), from 2000 to 2024 the biggest single contributor to GDP growth was consumption, aka consumer spending.

But in 2025, a much larger contribution has come from nonresidential investment.

Looking even more closely, in 2025 nonresidential investment has almost entirely consisted of artificial intelligence-related investment from companies (right hand side).

This shows that even when consumer spending is slowing, other areas of the economy can make up for it, leading to positive growth.

Going forward, it will be increasingly important to monitor not just consumer spending but other forces such as artificial intelligence investment spending and how they are driving growth in the new economy.

Inflation

Next, I’d like to discuss some developments we’re seeing with inflation, and why we may be approaching a transition in the inflation outlook.

First, the Consumer Price Index (CPI) has greatly declined since peak inflation in 2022 and has generally trended lower.

More recently, however, the inflation rate has been rising—since April of this year (see the line chart, below).

This raises the question: Is this a temporary stall in the decline of inflation, or is it an early sign of a changing regime?

One of the major contributors to the decrease in year-over-year inflation has been a falling shelter component, which makes up roughly 35% of the CPI (see the line chart, below).

While the rate of change may be slowing, there is not yet much evidence of a change in the downward trend for shelter inflation.

It’s also important to keep in mind that shelter is one of the more lagging components of inflation, because of how it is reported. So it will be one of the last components to change and reflect current market conditions.

But elsewhere, we’re seeing indications of upward pressure on inflation rates that may signify a sustainable shift in the overall index.

For example, commodity prices have generally been rising since the end of 2024 (see the next line chart).

Commodities provide a valuable forward-looking indicator of inflation for two reasons:

Commodity prices have a significant impact on the cost of goods, since they’re the raw components of goods. As commodity prices increase, so does the cost of goods sold. Those higher costs are passed on to consumers, eventually resulting in higher prices paid by consumers (higher commodity prices, higher goods inflation). Commodity prices also influence services inflation—mainly the cost of energy needed to provide services—but they have a much more direct impact on the cost of goods.
Because commodities are a tradeable market, they can also signal that the market is anticipating an increase in inflation.

My key takeaway is that as commodity prices increase, we can likely expect an increase in inflation in the near- to intermediate-term.

Looking at the breakdown between goods inflation and services inflation (on next chart), we see that goods inflation was on the rise since 2024 but services inflation continued to fall.

Now, goods inflation is continuing to rise and services are no longer putting downward pressure on the overall inflation rate.

This is why I believe we’re likely nearing a transition point with inflation.

Falling shelter and services inflation have been pulling inflation down despite rising commodities and goods inflation.

But eventually, and potentially soon, the overall inflation rate will no longer have this downward pull, as we’re already seeing with services inflation, and overall inflation will start to rise.

The Federal Reserve

Finally, a quick update on the Federal Reserve since its meeting in September.

Four times a year, the Fed’s Federal Open Market Committee (FOMC) updates its Summary of Economic Projections, and September’s meeting was the latest update (table, below).

I think the two most significant changes were:

1) Higher real GDP projections for this year, 2026, and 2027.

2) An increase in projected Federal Funds Rate cuts through 2027.

So despite projecting more economic growth, the FOMC is also projecting more rate cuts.

And since its September meeting, the market has also anticipated more rate cuts.

CME FedWatch Tool analyzes the implied market expectation of Federal Funds Rate changes via the Fed Funds’ futures market.

Through the end of the year, the market expects the most likely scenario to be another 50 basis points (0.5 percentage points) of cuts from the current target rate range of 4.00% - 4.25%:

The 2-year U.S. Treasury yield can also be analyzed as a forward-looking indicator of FOMC policy.

As the chart below shows, the 2-year yield tends to lead changes in the Federal Funds Rate. The chart also shows that the 2-year Treasury market is projecting a lower Federal Funds Rate:

Tying it all together

So how do we combine all of this to provide a market outlook?

Given what we’ve discussed, we draw the three following conclusions:

1. It should be a positive environment for risk assets, particularly stocks

2. Short-term Treasury notes (like the 2-year) could continue to appreciate in value

3. We expect a lower return on cash

First, let’s look at risk assets.

Strong economic growth is positive for business activity and earnings. And earnings drive stock market returns.

As long as economic growth remains conducive to business activity, we think this creates a positive environment for stock returns.

Additionally, Federal Reserve rate cuts have historically been positive for the stock market, particularly for sectors that are more sensitive to interest rates such as small-cap stocks, which have greatly underperformed relative to large caps recently.

Stocks also can perform well in early rising inflation regimes, as long as economic growth remains strong.

Inflation becomes a problem if it rises to the point that the Federal Reserve must take action by raising interest rates or if economic growth begins to decline.

As for our outlook on risk assets, it will be important to keep an eye on economic growth and inflation.

Second, shorter-term Treasury notes like the 2-year could continue to appreciate in value.

We discussed the outlook for the Federal Funds Rate and the 2-year Treasury. If the 2-year Treasury rate continues to fall, their prices rise. (Remember that bond yields and bond prices have an inverse relationship. As yields go down, prices go up.)

And if the 2-year yield continues to fall, that’s good for 2-year bond prices.

But again, if the market reverses and yields begin to rise in anticipation that the Fed will reverse course, our outlook would change.

And finally, our rising interest rate outlook means cash returns will likely suffer. Cash-like investments such as money market funds and Treasury bills will see lower interest rates if the Fed Funds rate continues to fall.

As we discussed earlier, the Fed Funds Rate is highly influential on short-term rates such as T-bills and money market funds, which invest primarily in short-term debt such as T-bills). So cash-like investments will likely have lower income rates.

This is not all bad. Lower returns on cash create an incentive for investors to look for better returns, and could be a catalyst for large amounts of cash entering other markets in a search for higher returns.

I know this was a long one, so if you made it to the end, I appreciate your hanging in there.

I’m looking forward to discussing these views further in our quarterly market webinar on Friday, October 10th at 4:00pm ET.

All the best,

Kyle

Market Commentary: More Growth—and Rising Inflation?