January 30, 2026
As we flip the calendar into February the usual early month data for the manufacturing and non-manufacturing purchasing managers’ reports and employment data for January are on tap. Those reports seem unlikely to cause any problems. Ditto for the fourth quarter GDP report later in the month. The closest thing to a soft report is likely to be retail sales for January which should get clobbered by the winter storms and extreme cold weather that have blasted most of the country for the past two weeks. But that is a weather-related event which will largely be offset by a sales rebound in February. The overall picture still seems favorable with moderate GDP growth continuing early in the year, steady inflation, and no change in the funds rate for the foreseeable future. Meanwhile, the stock market continues to achieve record high levels every couple of weeks.
The purchasing managers’ indexes, if anything, are on the upswing. Not so much for the manufacturing sector which has been fluctuating in a range from 47-50 for the past couple of years which means it is still contracting slightly every month. But the far larger nonmanufacturing sector has surged to the upside. The business activity component has risen 6.1 points in the past three months to 56.0 which is its highest level in a year. The gain has been led by the orders component which has surged and by service sector employment which has climbed slightly above the breakeven level of 50.0 for the first time in two years.
Payroll employment for January should register another modest gain of perhaps 60 thousand with the unemployment rate steady at 4.4%.
Initial unemployment claims, which are a measure of layoffs, have edged lower in recent weeks. That does not appear to signal a pickup in the pace of hiring, but it does seem to take off the table the risk of a much softer than expected report. The Fed continues to worry that an unexpected slowdown in the pace of economic activity could significantly weaker the labor market. But we see neither a slowdown in the economy nor any weakening in the labor market.
When we formulate our GDP outlook we expect a solid 3.8% pace in the fourth quarter, followed by a weather-reduced 2.5% GDP growth rate in the first quarter, and a rebound to 2.9% in the second quarter.
On the inflation front the core CPI and personal consumption expenditures deflator seem more likely to shrink slightly in the months ahead than to accelerate. Given little change in home prices, the shelter component is almost certain to slow from 3.2% today to 2.2% by the end of the year which will subtract 0.3% or so from inflation in 2026.
At the same time the Fed has finally eliminated all of the surplus liquidity it created in the wake of the 2020 recession which should also put downward pressure on the inflation rate.
As a result, we expect both the core CPI and PCE deflators to essentially reach the Fed’s targeted 2.0% inflation rate by yearend.
The funds rate seems to be essentially at a “neutral” level which means that it is neither stimulating nor retarding the pace of economic activity. The current funds rate is 3.6%. Most Fed officials peg a neutral funds rate at the 3.0% mark. In their minds the current level of the funds rate is indicative of slightly restrictive Fed policy. However, nearly half of the members of the Fed’s Open Market Committee believe that the so-called neutral rate is between 3.5-4.0% in which case Fed policy is already neutral. If the inflation rate slows a bit in 2026 and begins to approach the 2.0% target, the Fed may be able to eek out another 0.25% rate cut sometime around midyear, but it cannot go far. Trump may believe the neutral rate is 1.0% but, with the exception of Trump allies Stephen Miran and Christopher Waller, no other Fed officials believe that is the case.
Some market participants are disturbed by the recent rise in long-term interest rates. The yield on the 10-year Treasury note has risen somewhat in the past three months to 4.24%.
To determine whether that rate is high or not we look at the real or inflation-adjusted rate. With the 10-year yield at 4.24% and the inflation rate at 2.6% the real yield on the 10-year is 1.6% which is higher than the 0.7% real rate that existed in the 10-year period prior to the 2020 recession. It has not risen because of higher inflation expectations. The implied inflation rate for the next 10 years (as measured by the difference between the nominal 10-year Treasury rate and the inflation-adjusted rate) has been steady at 2.3% for more than a year. The increase in the 10-year rate is more likely to reflect the sheer size of Treasury debt outstanding combined with slightly reduced foreign demand for Treasury securities. That is unlikely to be reversed in the months ahead. For what it is worth, we expect the yield on the 10-year note to be 4.0% at yearend if inflation slows to 2.2%. In other words, the real rate at yearend is likely to be about the same as it is currently.
Meanwhile, the stock market seems to envision moderate growth, relatively low inflation, and a slightly lower interest rate environment as AI increases productivity, boosts GDP growth, and increases corporate earnings.
While there are always potential hiccoughs, for now relatively smooth sailing seems like the best call.
Stephen Slifer
NumberNomics
Charleston, S.C.
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