The US economy in the hot seat: 7 big questions

The US economy is growing, but how broad is the base supporting it? Strong headline numbers conceal an uneven picture across households and industries. At Finance Forward, I addressed seven questions clients have been asking me about the US economy. Here, I share my answers, exploring what is powering growth, where vulnerabilities lie and what it means for the outlook.

The US economy continues to perform well, although it masks growing divergencies between sections of the economy. High income households continue to spend strongly, boosted by large wealth gains in recent years, while middle and lower incomes are being squeezed by slowing income growth and elevated inflation. Similarly, tech investment continues to soar on the insatiable appetite to invest in data centers to facilitate the growing demands from AI, while non-tech is languishing.

The jobs market sees similar bifurcation. Government, leisure and hospitality and private education and healthcare services are adding jobs while other sectors are seeing flat to modest declines in employment levels. One sector that is showing signs of revival is manufacturing, with jobs gains of 72,000 year-to-date after three consecutive years of declines. Again, there is a wide range of performance with advanced manufacturing output (electronics/technology, transport and aerospace, specialty chemicals, pharma & power) experiencing robust growth, while more commoditized manufacturing, where it is difficult to charge a premium for made in America products, is seeing output fall.

Right now, there appears to be little prospect of an imminent slowdown in the strong performing sectors. Unemployment is low and asset prices are robust while tech investment has a strong pipeline. Nonetheless, the Middle East situation is putting upward pressure on energy costs, rising bond yields are adding to stress in interest rate sensitive sectors, while tech valuations are causing some concern about potential asset bubbles developing. When facing economic challenges, we want the broadest platform for growth to withstand any shock. The concentration of growth perhaps creates some vulnerability.

Tech investment in data center construction and the technology that goes inside them are making a huge contribution to overall GDP growth, but we need to remember that much of this technology is imported and we need to subtract that from the calculation. In net terms, we believe the AI/tech investment story is contributing around one third of GDP growth. However, the disappointing thing is that this appears to be cannibalizing growth, rather than supplementing, from elsewhere since non-tech related capex has been very weak. Hence why the YoY rate of GDP growth has slowed from 3%+ in 2023/24 to 2-2.5% in the first half of 2026. Consumer spending relating to AI token purchases is currently very small.

Since 2021 tech and non-tech investment have had an inverse relationship. When tech spending surges, non-tech spending has fallen. When tech spending slows, this has created space for non-tech investment to strengthen. This goes back to the earlier point about the tech roll out effectively cannibalizing growth from elsewhere rather than supplementing growth more broadly. So should the tech sector experience a gradual cooling, this should create an environment for non-tech to breathe and strengthen. However, if there is an abrupt slowdown in tech, say from an equity or debt market correction, that tightens financial conditions for the sector, this risks undermining sentiment more broadly. Such an environment would risk a broader, more concerted slowdown in US economic activity.

Over the past 25 years, workers have not been receiving the same rewards from economic growth that they once did. In 2000, for every $1 increase in economic activity, workers would typically accrue around 62 cents of that in employee compensation. Today that has dropped to just 52 cents. This underscores the point that many households are not feeling the benefits of economic growth. Instead, those owning assets are gaining more of the rewards via corporate profits and interest income. AI productivity improvements may well yield big wins for workers in time, but there is the concern that the transition to that point could come with further pain with workers receiving even less of the benefits of growth in the near-term, particularly if there are job losses. This is already tentative evidence of this in the finance, insurance and professional services sectors.

Federal Reserve interest rate increase won’t re-open the Strait of Hormuz and they are probably not going to do much to restrain the big tech companies from spending aggressively on AI related activities. However, it is increasingly hurting the weaker parts of the economy.

We don’t expect any shift in the US-Iran conflict ahead of the mid-terms. Assuming that after the elections we do see an agreement to improve the flow of energy (with lower shipping costs) from the Persian Gulf this should meaningful ease inflation pressures globally and we don’t think the Fed will go further beyond the December hike we are forecasting. However, the risk is clearly tilted towards a longer lasting conflict rather than one that is resolved imminently. This means we would not rule out an additional hike in 1Q 2027.

The US is running a primary deficit of 2.5% of GDP, that is to say that departmental government spending exceeds tax revenue by 2.5% of GDP. Add in debt service costs, which are running at 4% of GDP this gives an overall deficit of 6.5% of GDP at a time when the national debt is around 100% of GDP. High borrowing costs look set to persist and the mid-term elections look set to yield a split Congress, which means no prospect of any shift in the fiscal position of the US. As such the US debt position looks set to deteriorate further. 

However, all is not lost. If nominal dollar GDP growth exceeds the increased dollar cost of the debt servicing, by more than the size of the primary deficit, the debt to GDP ratio can still fall. So, if AI/tech does yield big productivity and growth gains, resulting in higher tax revenues and more efficient government spending, the US fiscal position can quickly look much better.