By Brian Johnson, Director of Investment Services

As we reach the midpoint of 2025, the U.S. economy continues to show its resilience. However, there are some signs of cooling on the horizon.

The Federal Reserve’s Federal Open Market Committee’s (FOMC) preferred measure of inflation, the Personal Consumption Expenditures (PCE) Index, increased 0.1% for the month of May, an increase that brought the year-over-year increase to 2.3%. As the PCE indicator trends closer towards the FOMC’s preferred inflation target of 2%, uncertainty is in the air about how future policy implementations and economic conditions may impact PCE readings moving forward.

The Consumer Price Index (CPI) is the FOMC’s other metric for measuring inflation. The Consumer Price Index (CPI) reading for May crept higher as well with a 0.1% increase over April’s reading but remained relatively stable. May’s CPI reading checked in slightly higher than May’s PCE reading, increasing at 2.4% year-over-year.

As it relates to economic growth, all eyes moving forward will be on the consumer. Consumer spending makes up nearly 70% of U.S. Gross Domestic Product (GDP) and data around the consumer was off to a slow start for the year, with the Conference Board’s Consumer Confidence survey declining for four straight months before rising 12.3 points in May.

Despite a resilience in retail sales during the first few months of the year, May’s retail sales number fell 0.9% on a seasonally adjusted basis in May, which comes on the heels of a 0.1% decrease in the month of April. Overall, retail sales are still up 3.3 % on a year-over-year basis compared to May 2024, according to the Commerce Department’s Census Bureau.

Looking ahead to the second half of the year, the strength of the consumer will be key in driving economic growth. The U.S. economy did slow slightly during Q1 2025, with U.S. GDP dropping 0.3% on an annualized basis, largely due to an increase in imports as companies tried to get ahead of tariffs. Continued tariff negotiations will play a large role related to economic growth in the second half of the year, with consumer spending likely hinging on the outcomes of those negotiations.

Further underscoring economic resiliency has been the strength of the employment market. Nonfarm payrolls increased by 139,000 in May, falling short of the 147,000 jobs created in April, but beating expectations of 125,000. The unemployment rate continued to hold steady at 4.2% for the month of May as well. Also notable from the May report was that worker pay grew more than anticipated. Average hourly earnings increased 0.4% during the month, which was up 3.9% from one year ago.

With what can generally be described as a mixed set of recent economic data, the FOMC left its target range for the benchmark federal funds rate unchanged at 4.25% – 4.50% upon conclusion of its June meeting, citing a “wait and see” approach to how potential trade policies will impact the economy. FOMC Chair Jerome Powell noted in his press conference that “For the time being, we are well positioned to wait to learn more about the likely course of the economy before considering any adjustments to our policy stance.”

Parsing through the FOMC’s statement further, the Committee reiterated ongoing threats in the market to both higher inflation and employment. In a statement following the June meeting, Federal Reserve governor, Michelle Bowman, stated “It is likely that the impact of tariffs on inflation may take longer, be more delayed and have a smaller effect than initially expected.” As a result, the FOMC continues to remain data dependent. The CME’s FedWatch Tool is pricing in a 72% chance of a 25-basis point cut at the FOMC’s meeting in September and a 55% chance of an additional cut at their meeting in October.

Looking beyond cash and overnight rates that track the fed funds rate and near-term expectations of its movement, we’ve seen yields continue their fluctuating patterns, rising and falling with the daily economic news. As many governmental investors enter budget season, we see opportunities to extend portfolio durations to match with future cash flow needs and the ability to generate additional yield beyond overnight rates in different areas of the fixed income market. Targeting a long-term investment strategy is a great way to build cash flow stability for your entity’s operating needs in today’s marketplace and for years to come.

If you’re interested in discussing your current or even different portfolio strategies, please contact your Ehlers Investment Adviser to learn more.

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