The Search for Goldilocks

Moving into the final quarter of the year, investors face a series of questions around key macroeconomic variables that will define the growth and risk asset outlook for 2026, and hope that the balance will get things “just right.” 

Looking back to the 1990s, the notion of a “Goldilocks economy” was created to describe an economic environment that was “not too hot, not too cold”—mirroring the fairy tale’s “just right” porridge. This metaphor caught fire, and even today most investors are familiar with the phrase as characterizing a beneficial balance of growth and inflation that allows the Federal Reserve to be accommodative with policy rates.   

Capital markets now hope that this “just right” scenario will play out, where the economy expands steadily without overheating (stoking inflation) or slipping into recession. While recent data is trending positively, it is fair to say we are all still testing the porridge and awaiting further clarity.   

The Fed meeting this week will command much of the market’s focus, but it is ultimately the macroeconomic data underpinning the pace of future rate cuts that should continue to preoccupy investors over the coming quarter.   

Labor and inflation data released in the past three months, including last week’s U.S. jobless claims and consumer and producer price index numbers, have strengthened expectations for continued monetary easing. Yet open questions remain about the growth outlook and the impact of any changes in underlying dynamics.   

Can the economy, for instance, remain resilient despite a softening job market? Can we be assured that the labor economy will maintain this subdued pace of job gains (or slight losses), or is the porridge losing its heat and putting us at risk of a material employment contraction? Is consumer strength sufficient to offset weaker employment? Will the impact of tariffs on inflation continue to be more benign than expected, or is it simply too early to declare victory?  

These questions will be top-of-mind for our Asset Allocation Committee ahead of its quarterly outlook discussion later this month, with significant implications for the equities outlook, the trajectory of rates, and the shape of the risk asset landscape more broadly.   

An Eye on Jobs 

Currently, the more pressing area to monitor is the labor market. We’ve now had two straight months of softness in nonfarm payrolls and now a surprising rise in U.S. initial jobless claims: They jumped 263,000 in the week through September 6. Indeed, these recent data releases show that not only has jobs growth slowed but, based on preliminary annual revisions by the Bureau of Labor Statistics, that an estimated 911,000 fewer jobs were created than previously thought for the 12 months ending in March 2025. 

Taken at face value, the revision implies that average monthly job creation may have been about half as strong as the 149,000 jobs per month previously reported. Overall, that would reduce the total number of nonfarm jobs by 0.6%, the largest downward adjustment since 2009. Combined with unemployment ticking up, clear warning signs are flashing in the labor market.  

In our view, these signs are not yet triggering recessionary fears, particularly as economists think the rate of breakeven employment growth is trending lower given declines in net immigration from border policies and deportations. This said, we remain vigilant regarding any acceleration in the deterioration of the jobs market.   

Keeping Inflation in Mind  

After mixed signals from the July Consumer Price Index and Producer Price Index numbers, last week’s August inflation data was more consistent in indicating that tariffs so far appear to be having a measured or moderate impact on prices.    

August CPI was in line with expectations, rising 2.9%—up from 2.7% in July—year-over-year with core CPI, excluding volatile food and energy prices, climbing 3.1%, the same as the previous month. Month-over-month, CPI rose 0.4%, slightly above consensus forecast.   

More strikingly, annual PPI increased only 2.6%, significantly decelerating from the 3.3% rate recorded in July and the 3.3% forecast. Core PPI in August increased 2.8%, down from 3.7% the previous month. On a monthly basis, PPI fell 0.1%, well short of the estimated 0.3% rise.  

Investors are eager to see how these more recent inflation trends translate into annual core PCE inflation, the Fed’s preferred measure, which increased 2.9% in July. While inflation levels are still well above target, they are trending more favorably than most expected as tariffs are being digested, which has given the Fed a more palatable dynamic to work with.   

A Dovish Tilt 

Clearly, labor market data has pointed to a more abrupt slowdown in employment than previously expected, which is sufficient to justify hitting the “play” button on restarting Fed cuts after “pause” was hit nine months ago. Investors are now fully pricing in a quarter-point rate cut this week—consistent with our view—and closer to anticipating a total of three rate cuts this year.

It is logical that the market has shifted to a more dovish posture, but markets are pricing more aggressive action by the Fed, with rate cuts through 2026 to a neutral rate closer to 3%. However, we think this terminal rate pricing may be too optimistic. The Fed’s dual mandates will be tested as inflation will likely remain well above its 2% target, which will make the monetary easing path complex and more uncertain than the markets seem to be expecting.

Looking Ahead 

As we move into the final quarter of the year, we believe there are good reasons to be constructive in our outlook on economic fundamentals and risk markets over the medium term, a view that has been consistent throughout the year. Playing into this is that corporate earnings remain strong, capital expenditure cycles are picking up, and even the IPO and M&A markets are stirring.  

Potential surprises in employment and inflation data, or some other macro or geopolitical event, could, of course, provoke short-term market volatility, and investors should be mindful of these risks as they manage allocations. As ever, and in this environment in particular, diversification across asset classes is important to mitigate any turbulence.  

In anticipation of those moments, it’s important to note that we see ample liquidity on the sidelines that would help absorb any shocks and act as a buffer for risk assets, as investors remain bullish on the long-term health of the economy and trajectory for earnings.  

While Goldilocks has yet to make her final choice on her favorite porridge, we think that once we emerge from the current period of deceleration, the stage is set for a “just right” balance between strengthening economic growth and manageable inflation in 2026, opening the door to a more accommodative monetary policy stance.