Eyes of Silver: Seeing through the hawkish narrative

The hawkish market narrative is overstating the durability of inflation and growth, creating room for lower rates as consumption slows and disinflation resumes.

• Second-quarter real GDP grew only 1.5%, but real final private domestic demand rose 3.9%, while real personal consumption expenditures increased by more than 2.1%, the fastest pace since Q3 2025.
• Consumption is likely to moderate in the second half of 2026 as real income growth remains weak, the temporary support from tax refunds and other fiscal impulses fades, and the labor market shows signs of deterioration.
• The fiscal impulse is expected to turn into a drag that intensifies through the first half of 2027, while AI-related capital expenditure growth is forecast to slow to 35% in 2027 from 73% in 2025 and 85% in 2026, despite budgets exceeding $1 trillion.
• The New York Fed’s multivariate core trend inflation measure has fallen for two consecutive months toward its late-2025 cycle lows, with improvement across goods, supercore services, and housing-related components.
• Shelter disinflation should continue into 2027 because market rents remain below pre-pandemic levels and feed into official measures with a lag, offsetting some persistence in supercore services.
• Markets have moved from nearly 70% cumulative odds of stable or easier policy in mid-April to just over 25% on August 3, implying roughly 75% odds of tighter rates by June 2027, a distribution the authors consider too hawkish.

Takeaway: Investors should resist pricing further Fed tightening as the central scenario; if labor data stay soft and core inflation continues to moderate, the market’s fat right tail of higher rates could compress and support a rally in bonds.