The Economy is on Solid Footing, but Risks Remain
- Inflation has likely peaked but will remain elevated for a prolonged period of time.
- The labor market hasn’t shown signs of cracking as hiring has exceeded expectations this year.
- The economy continues to run on two tracks, with wealth effects supporting spending by high-income households while lower- and middle-income households face price pressures.
The Details
Economic data from the second quarter indicates the economy remains on solid ground. Lower oil prices will reduce the drag on real incomes over the second half of the year, and consumer spending will continue to grow, supported by a job market that’s broadly in balance.
The Consumer Price Index (CPI) fell 0.4% from May to June, driven by a sharp drop in gasoline prices, pulling down the year-over-year inflation rate from 4.2% in May to 3.5% in June. Nevertheless, inflation remains elevated from the 2.5% growth rate in the second quarter of last year.
The bigger takeaway from the June report was the benign reading of core prices (excluding volatile food and energy). The Federal Reserve is worried about a broadening out of inflationary pressures across goods and services, and that wasn’t evident in the June CPI details.
The fall in gas prices is good news for consumers, as it will ease the pinch on wallets. Due to the war-induced surge in gas prices from March through May, inflation outpaced wage growth, leading to a drop in real earnings. That trend reversed last month with the plunge in gas prices lifting real earnings for the first time since January.
However, the negative impact from higher gas prices will reappear in July unless an unexpected end to the Mideast conflict suddenly appears. With savings depleted and tax refunds mostly spent, the major source of purchasing power for most households will come from earnings. Odds are that June’s growth in real earnings will be undone in July, as the rebound in prices at the pump will again take a bigger bite out of incomes.
Falling gas prices also helped ease consumers’ fears about inflation and contributed to a slight gain in June’s Consumer Confidence Index. Year-ahead inflation expectations fell for the first time in four months, although they remain above their pre-war levels. However, the June confidence survey was completed before hostilities with Iran re-ignited, and consumer confidence in July could be undermined by gas prices that are rising again.
Even before energy prices rose with the renewed hostilities with Iran, core inflation was expected to remain above the Federal Reserve’s 2% target longer than previously projected. In addition to higher energy prices, there are indications that the AI-driven shortage of memory chips is starting to push up the costs of smartphones, computers, and related products. Even if oil prices remain below their peak from earlier this year, AI-related demand will keep electronics inflation elevated. Thus, we’re not out of the woods on the inflation front.
Job gains in Q2 averaged 111,000 per month, a solid number, particularly given the contraction in the labor force since the start of the year. The unemployment rate ticked lower in June, to 4.2% from 4.3% in April and May. The unemployment rate is likely to remain low, even if hiring softens, as retiring baby boomers and restrictive immigration policies curb growth in the labor supply.
In the housing market, the NAHB homebuilder sentiment index fell in July, indicating weak housing activity. Affordability challenges, driven primarily by elevated mortgage rates, rising material costs, and heightened economic uncertainty, are likely to keep sentiment depressed in the coming months. Meanwhile, pending home sales fell more than expected in June, but the decline wasn’t all that surprising given that mortgage rates in June were the highest since August 2025.
With the labor market not showing signs of weakness, the Federal Reserve can be patient given the elevated pace of inflation and is expected to stay on the sidelines for a prolonged period of time. There are no signs that the economy needs help from a looser policy, although the tepid housing market would certainly benefit from lower mortgage rates. The Fed’s next move is likely to be a cut in interest rates, but the timing has been pushed back to Q3 2027.
While economic conditions are broadly positive, household-level conditions remain differentiated by income. Thus, the K-shaped economy remains a key economic theme. Wealthier households, boosted by roughly $9 trillion in Q1 stock market gains, are propping up high-end housing (sales of $1mn+ homes rose sharply) and discretionary spending.
On the other hand, lower- and middle-income consumers face depleted savings, rising delinquencies, tightening bank lending standards, and falling real wages.
The pressures on lower- and middle-income households mean consumer spending is increasingly reliant on higher-income consumers. A pullback in the stock market would change conditions for those households, posing some risk to the outlook for consumer spending.
Robust Travel in the Second Quarter of 2026
- Hotel demand has risen every month this year.
- The impact of the FIFA World Cup is becoming apparent, with hotel rates benefiting the most.
- International travel by US residents has softened, potentially benefiting the domestic travel industry.
The Details
Travel demand remains strong, with hotel demand rising every month this year, but there are indications that travelers are responding to price pressures.
Hotel demand was up 1.8% year-to-date through June, and demand grew 2.0% or more in 4 out of 6 months this year. Conversely, TSA checkpoint volume in US airports was flat (0.3%) through June, with widening declines in May (-0.7%) and June (-1.3%).
This combination of rising hotel demand with softening passenger volumes may be a sign that some travelers are substituting road trips in place of airline travel due to mounting price pressures. This shift could be impacting destination choice, as some travelers may be opting to drive to destinations closer to home.
It may seem counterintuitive that road trips could increase when gas prices rise. However, an increase in the price of gas represents a relatively small percentage of the overall cost of a trip when accommodations, food, and entertainment are included. Conversely, higher airfares due to rising fuel costs have a larger impact on travel budgets. The airfare component of the Travel Price Index rose 26.3% in the second quarter versus the same period last year.
Historically, the travel industry has observed that higher gas prices don’t cause a significant downturn in travel. Rather than not traveling at all, travelers can offset higher prices in one travel category with reduced spending in other parts of their travel budget, and a shift from air travel to road trips could be an example of that.
Higher airfares may also be contributing to a pullback in US residents traveling outside the country. Outbound air travel by US citizens has fallen below prior year levels for 4 consecutive months. Significant events, including the FIFA World Cup, America 250 celebrations, and the 100th anniversary of Route 66, may also be contributing to a shift towards domestic travel this year.
The domestic travel industry, including hotels and short-term rentals, stands to benefit if US citizens substitute a domestic destination in place of an international trip.
The FIFA 2026 World Cup kicked off in June to much fanfare and speculation about the impact on the travel industry. As anticipated, the available data indicates the impact was greatest on hotel rates, with a relatively muted impact on hotel demand. June’s hotel data points to approximately 15% growth in average daily rates (ADR) among host markets, versus about 5% ADR growth in non-host markets.
However, higher hotel rates have the potential to cause demand displacement, where non-fans avoid host cities due to crowds and high prices. June demand in host markets was flat to down slightly, while demand in non-host markets was up about 2.5%.
The solid demand growth in non-host markets in June was an encouraging sign of strong travel activity entirely separate from the World Cup.
Unfortunately, the World Cup was unable to reverse the decline in overseas visitors, and overseas arrivals to the US declined 1.8% in June.
Overseas arrivals to the US have declined 4 out of 6 months this year and were down 4.3% year-to-date through June. This was on top of a 2.8% decline in overseas arrivals during the first half of last year. Effects related to the Middle East conflict have played a role, adding elevated fuel costs and air travel disruptions, but it’s clear that challenging sentiment toward the US continues as a contributing factor.
That’s not to say the World Cup had no impact on international travel in June, as arrivals from many World Cup participating countries posted strong growth in the month.
- Overseas arrivals from World Cup participating countries rose 1.7% in June, while arrivals from non-participating countries declined 6.7%.
- Several countries more than doubled the volume of arrivals from June of last year, including Paraguay (212.4%), Croatia (187.8%), and Morocco (103.9%).
- In addition to Paraguay, arrivals from other South American countries also experienced significant increases: Uruguay (55.0%), Ecuador (54.9%), and Colombia (21.4%).
- June arrivals from the United Kingdom, including England and Scotland, increased 16.9%, and arrivals from Austria rose 24.5%.
- And Norwegians flocked to the US to watch Erling Haaland, whose popularity soared during his team’s run to the quarterfinals. Arrivals from Norway rose 66.2% in June.
The Monthly Economy & Travel Industry Summary partners with Tourism Economics, an Oxford Economics company. Combining rigorous economic analysis with decades of travel industry expertise, Tourism Economics is an industry-leading insight resource. Learn more at www.tourismeconomics.com.
