Economic Outlook
October 2026
Overview: Growth Continues, but Momentum is Moderating
The U.S. economy continues to expand, supported by still-positive growth, resilient consumer spending, and ongoing business activity. However, growth momentum has moderated as labor market conditions soften, inflation pressures reaccelerate, and interest rates move higher. While a recession is not the base case, the outlook remains increasingly asymmetric, with downside risks dominating and growth becoming more vulnerable to policy uncertainty, tighter financial conditions, supply-chain disruptions, financial market volatility, and geopolitical shocks.
Economic Growth: Positive but Increasingly Fragile
Economic growth remains positive, with manufacturing and services continuing to expand and the October consensus forecast still pointing to moderate growth and no recession. Consumer spending remains a key source of support, but weak confidence, slower real-income growth, and elevated borrowing costs are creating headwinds for future activity.
The U.S. economy is expected to continue growing through the remainder of 2026, although the combination of higher interest rates, persistent cost pressures, policy uncertainty, and a softer labor market suggests momentum is moderating. Recession is not the expected outcome, but the margin for error has narrowed.
Labor Market: Cooling Without Collapse
The labor market continues to cool, although not in a manner consistent with broad-based job losses. Following August's improvement, September payroll growth slowed to just 29,000 jobs, while downward revisions to July and August reduced the three-month average gain to 51,000.
Despite softer hiring, announced layoffs remain relatively contained, suggesting businesses are managing through slower hiring, attrition, and workforce adjustments rather than widespread workforce reductions. The labor market remains supportive of continued expansion, but the pace of job creation has weakened materially and warrants close monitoring.
Businesses are still growing, but the margin for error is tighter. Inflation, labor dynamics, policy uncertainty, and geopolitical uncertainty pressure every decision. For middle market companies, discipline matters — understand your liquidity, operating model, and where to invest through the cycle. Those protecting flexibility and making thoughtful capital decisions will be best positioned.
Ken Gavrity
President
Key Commercial Bank
Inflation, Policy Uncertainty, and Geopolitical Risk: The Central Challenge
Inflation has strengthened in recent months, driven in part by higher energy prices, tariff-related pressures, and lingering supply-chain strains. While underlying inflation trends remain more moderate than headline measures suggest, progress toward the Federal Reserve's long-run target has become less certain.
Businesses continue to face persistent cost pressures, while policymakers must balance inflation risks against signs of moderating economic growth. Geopolitical tensions, trade uncertainty, and energy market developments remain important sources of upside inflation risk and economic volatility.
Monetary Policy: Limited Flexibility, Renewed Tightening
Monetary policy remains constrained by persistent inflation pressures. In September, the Federal Reserve resumed tightening, increasing the federal funds target range to 3.75% to 4.00%.
Most policymakers continue to anticipate additional tightening later in 2026, reflecting concern that inflation could remain above target longer than previously expected. Higher interest rates are likely to create additional pressure on housing, commercial real estate, business investment, and other interest-rate-sensitive sectors. Financial markets continue to assess the extent to which inflation persistence and slower growth can coexist without significantly weakening economic activity.
Business Activity: Resilient but Cautious
Manufacturing remains in expansion territory, while services activity continues to grow. Business conditions have proven more resilient than many expected, although sentiment varies considerably across firm sizes.
Confidence among larger companies has improved, while small-business optimism has softened amid weaker expectations for sales, earnings, hiring, and capital spending. Businesses continue to navigate persistent cost pressures, policy uncertainty, cybersecurity threats, and the opportunities and risks associated with emerging technologies and artificial intelligence. As a result, many organizations remain cautious when making hiring and investment decisions.
Housing: Demand Can't Overcome Affordability Headwinds
Housing remains constrained by affordability challenges, as mortgage rates above 6%, subdued buyer demand, elevated inventories, and rising construction costs weigh on activity and builder confidence.
Underlying demographic demand and accumulated housing shortages continue to support the long-term outlook. However, as borrowing costs remain elevated, the housing recovery is expected to be gradual rather than rapid.
Downside Risks: Policy Uncertainty, Geopolitics, and Financial Conditions
Downside risks continue to dominate the outlook even as a soft landing remains the base case. The principal risk scenarios include:
- A renewed acceleration in inflation driven by energy prices, tariffs, or supply-chain disruptions
- Additional monetary tightening and tighter financial conditions
- Financial market volatility that weakens business and consumer confidence
- Geopolitical escalation that disrupts trade, energy markets, or global supply chains
- A more pronounced slowdown in hiring and labor market activity
- Fiscal uncertainty associated with potential government funding or debt-ceiling disputes
Concluding Perspective
The current macroeconomic picture remains one of cautious resilience under increasing pressure. Economic activity continues to expand, business activity remains generally healthy, and the consensus outlook does not anticipate recession. However, growth momentum has moderated as hiring slows, inflation reaccelerates, and higher interest rates create additional constraints on consumers and businesses.
The base case remains a soft landing, but the path has become more challenging. Inflation, policy uncertainty, geopolitical developments, and tighter monetary policy continue to cloud the outlook, while downside risks remain elevated. In this environment, resilience, liquidity, and disciplined risk management remain critical as businesses navigate an increasingly uncertain economic landscape.
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