Kudlow says Goldilocks economy returns as Fed balances growth, inflation

The US economy has entered a Goldilocks period of balanced growth and easing inflation, Larry Kudlow said, a scenario that could extend the equity rally through year-end.

"The economy is growing at a solid pace while inflation continues to ease — that's the sweet spot for markets," Kudlow, former director of the National Economic Council and Fox Business host, said in a July 16 commentary.

The assessment comes as the Federal Reserve holds its benchmark rate steady after cutting by 25 basis points in September 2025, its first reduction since the tightening cycle began. The S&P 500 has gained roughly 12% year-to-date, while the 10-year Treasury yield has declined to around 4.1% from its April peak of 4.7%, reflecting growing confidence in a soft landing.

A sustained Goldilocks environment would allow the Fed to continue gradual easing without rekindling inflation, potentially supporting further multiple expansion in equities. OIS markets currently price a 68% probability of another 25-bp cut at the September 2026 meeting, according to CME FedWatch data.

The Fed's Delicate Balance

Fed Chair Kevin Warsh has signaled caution on the pace of easing, telling reporters after the June meeting that the central bank needs "greater confidence" that inflation is sustainably returning to its 2% target before committing to further cuts. That language mirrors the Fed's stance in late 2024, when officials held rates steady for eight months before eventually cutting in September 2025.

The personal consumption expenditures price index — the Fed's preferred inflation gauge — has moderated to an annual rate of 2.4%, down from a peak of 7.1% in June 2022. Core PCE, which excludes food and energy, stands at 2.6%, still above the Fed's 2% target but trending in the right direction.

What Goldilocks Means for Markets

Historically, Goldilocks periods have been among the most favorable for equities. The last such stretch, from mid-2023 through early 2024, saw the S&P 500 rally 24% as the economy grew above trend while inflation cooled from 3.4% to 2.4%. Technology and consumer discretionary sectors led the advance, with the Nasdaq Composite gaining 38% over the same period.

Kudlow's commentary also highlighted the role of technology in driving productivity gains, noting that the "technology revolution will continue to surprise on the upside." This aligns with recent data showing nonfarm business sector productivity rising at a 2.3% annualized rate in the first quarter of 2026, well above the 1.5% average of the past decade.

The Risk Scenario

Not all economists share Kudlow's optimism. The biggest risk to the Goldilocks narrative is a reacceleration of inflation driven by tight labor markets or supply shocks. Nonfarm payrolls have averaged 185,000 per month over the past three months, above the 100,000 breakeven rate estimated by the Atlanta Fed, suggesting the labor market remains tight enough to keep upward pressure on wages.

If inflation were to reaccelerate, the Fed would be forced to pause or reverse its easing cycle, a scenario that Warsh's cautious language has left open. The last time the Fed used similar "greater confidence" language was in December 2024, which preceded a seven-month hold before the September 2025 cut.

This article is for informational purposes only and does not constitute investment advice.