Vito Sperduto
Welcome to Strategic Alternatives, a podcast series from RBC Capital Markets. I'm Vito Sperduto, head of RBC Capital Markets U.S., and today, we're looking ahead to our U.S. economic outlook for 2026. It has been a year that challenged a number of long held assumptions about how the U.S. cycle behaves. We talked earlier in the year about the risk of stagflation-lite dynamics, and the question now is whether those forces persist or evolve into something different as we move into the new year.
Vito Sperduto
One complicating factor is that economists are building their 26 views in a period where the government shutdown has delayed a significant amount of economic data. We have limited visibility into several months of the year, and the longer this data gap extends, the more it risks distorting the inflation picture at a time when the Federal Reserve is setting the pace for additional rate cuts. Another major focus for us is the U.S. consumer. The consumer has not weakened in a broad sense, but the distribution of spending power has changed. Household wealth has become more concentrated in older and higher income Americans whose liquid asset gains are supporting consumption. At the same time, the bottom 80% of households have very limited financial buffers after several years of cumulative price increases. That K-shaped pattern is influencing how businesses think about demand, how investors interpret the data and how policy makers calibrate both monetary and fiscal responses. We are also watching how labor markets evolve, how confidence influences investment decisions, and how government policy is shaping industrial strategy, capital allocation and sector level opportunities. Additionally, the rise of artificial intelligence continues to influence not only productivity and innovation, but also how leaders think about workforce planning, capital spending and competitive positioning. Our goal today is to bring a forward-looking, thematic lens to all of this so that our clients can navigate uncertainty and prepare for what comes next. Joining me are our chief economist Frances Donald, and our U.S. economist Mike Reid. They will walk us through how we are framing the 26 outlook, what the consumer and labor market are signaling, and the themes we believe matter most as we head into the New Year.
Francis, Mike, welcome to the podcast.
Frances Donald
Thanks, Vito, happy to be back.
Mike Reid
Thanks, Vito, thanks for having us back on.
Vito Sperduto
All right. Well, let's kick it off. It's outlook season for economists, including our team here and others around the world, who are pulling together views on 2026. But it must be harder to think about that future when, as I mentioned, the government shutdown means we still don't have some critical data and visibility into what happened in recent months. The most recent US CEO confidence survey from the Conference Board shows business leaders growing more cautious. Many anticipate a mild slowdown, with lingering inflation pressures and the biggest concerns on their minds center around geopolitical instability, cyber risk, the speed of AI adoption and a larger policy footprint as government plays a bigger role in industrial strategy and investment. So, Francis, why don't we start with you? How are you guiding a forecast when one of our most important tools is blind for several months?
Frances Donald
Vito, you're right. It's definitely been harder, but economists are scrappy. We develop plans, we figure out a way forward. So effectively, our team has had a two-pronged approach through this more complicated period. The first one is to use what we have, and that's not nothing. There has still been a reasonable amount of privately produced data, particularly on the jobs number side. So, we've got state unemployment claims, things like the ADP, some confidence measures, as you mentioned, and companies still talk, and we still listen, we have enough to feel confident that the job market in the fourth quarter has been on the softer side, but certainly still stable and very far from cracking.
Frances Donald
The big problem has been we don't have much on the inflation side of the picture. That is a much bigger black hole. We know that CPI data was not collected in the month of October at all. And just a reminder, what's so interesting about inflation data is about two thirds of it is collected by in-person visits so statistical agents who walk around brick-and-mortar stores and actually look at those prices. And that just didn't happen in the month of October, in November, even though the government is open, that collection process has basically been at a standstill for nearly two weeks. So there's collection issues at play as well. So, there's much bigger of a problem on the inflation side, and that's why we need this second prong to the two-pronged approach, which is to try not to get too cute about exactness in Q4.
Frances Donald
The hard truth for us is that a great deal of the data over the fourth, course of Q4 and probably into the first quarter, is going to be distorted. It will be much harder to read. And of course, tariffs aren't helping that. There's still a lot of distortions at play there. And there's a little secret, not too much of a secret, in the economist community, that q1 data tends to suffer from seasonality, and so that means we're probably not going to be able to get too obsessive about the decimal points on anything until the second quarter. That's a long time Vito to not have a lot of visibility, and that's why we need to focus a little bit on the broader themes. What do we know to be true, and what is the momentum underlying this economy? And maybe that's a good, forced exercise, because I do think sometimes we get too obsessed with the week to week or the month to month. We miss the forest for the trees. So, what we do know about the United States is enough to put together five big stories that we think will be relevant in 2026 even if, for example, we don't have an October unemployment rate to guide us.
Vito Sperduto
Well, as you mentioned those five stories, let's dive into those five core themes you're watching for the year ahead. We've heard a lot about stagflation in ‘25. How is that term going to be used the same or differently in ‘26 and is it more accurate now to talk about a fragmented economy rather than a stagflation narrative as you're thinking about it.
Frances Donald
Yeah, I think both are true Vito, and you've really highlighted something that's so core to us, which is that when you open up our forecast at rbc.com/economics, you're going to see what we think happens to the US economy as a whole. But those average numbers do tend to overstate some strength in the economy and understate it in others. So, Mike and I spend a lot of time thinking about, where is this big headline number true, and where is it? Maybe not as representative. Unfortunately, I think this concept of stagflation light will persist for us in 2026 and maybe become even a little more aggravated. We've been talking about stagflation light, emphasis on the light, for well over a year, and it's effectively our way of saying that growth is likely to be too low for comfort and inflation is likely to be too high for comfort. Of course, this is not the 1970s with runaway inflation or double-digit inflation, but it's still a challenging macro picture when you have both sides of that economy going in opposite directions. Now, to give you a little bit of a sense of what does growth slightly below comfort look like? Well, the growth picture in 2026 is going to look fairly similar to 2025 and while forecasts change, just to give you sort of a ballpark here, last year 2025 we thought growth would run about 1.8% in 2026, 1.6%. let's not split hairs. That's effectively saying that growth is still going to remain above that sort of psychological level of 2%.
Frances Donald
Our bigger worry, though, is on the inflation side of this stagflation-lite theme, that's going to weigh more heavily, and effectively, we see core inflation rising to as high as three and a half percent by the middle of 2026 you know, you and I both know that is way outside everyone's comfort zone, especially because we've just had four years, four and a half years, of inflation already running above the Fed's 2% target. We're not getting back to 2% particularly on core measures, by the end of 2026 so you know, for as long as I've been an economist, Vito the main question has always been, are you in the recession camp or the no recession camp? And there's a sort of obsession with recession means bad and no recession means good. But there's a complexity that's coming alive within this U.S. economy that speaks to a different type of complicated environment. And in some ways, while I would never wish for a recession, that means people are unemployed, they have trouble getting food on the table. There's all sorts of challenges. Sometimes something like a growth scare that comes with disinflation has an easier policy prescription, has an easier investment playbook, because we've seen them before. We don't have a lot of playbooks for this more complex stagflation light environment, and that's why a lot of our jobs as economist is to say, Okay, in this more complex environment, where are the risks, where are the opportunities? And if the economy is increasingly fragmented, how should we think about it differently? How do we help our clients and our companies that we speak to navigate a very different operating environment?
Vito Sperduto
So, given all that, are you watching more closely, say, fiscal and industrial policy versus what's being done from a monetary adjustment perspective?
Frances Donald
That's a fair takeaway. What a complicated environment for central banks. This isn't just a U.S. environment, but also happening globally around the world, which is when you have tension at both sides of your dual mandate. If you have a dual mandate, it tends to sort of handcuff you. And this is going to be a challenge for the Federal Reserve heading into 2026. Clearly, this is a fed that wants rates to be lower, closer to their concept of the neutral rate, but with inflation accelerating, it makes it more difficult, versus a straight up recession or boom times. Policy prescription is clear. This is an economy, just like many developed economies around the world, in Europe, in Canada, in Australia, that's going to need to lean more on fiscal policy. But of course, that comes with different implications.
Vito Sperduto
Mike, why don't we switch over to the consumer? And I know you've been on top of the changing nature of the US consumer for several years now. What's the new part of the story today? You know what? What makes you so passionate about this topic and you know, we've talked also a lot about the fact that many CEOs, as they think about their businesses, and also policymakers, sometimes misread this, because they're looking at the quote, unquote average consumer. And you know, how do we correct that?
Michael Reid
Yeah, there's a lot going on right now. On the one end of the income spectrum, you have a consumer that's holding up a really propelling consumption growth, and you know, they aren't feeling a lot of the stress right now, primarily due to the shift in price levels that we've seen over the past five or so years in this post covid environment. At the same time, you have a middle- and lower-income consumer who are really starting to feel the pinch of inflation against the backdrop of slowing wage growth, and this is a really important distinction in the US economy, because, you know, historically, GDP growth has been driven by the consumer. It will continue to be driven by the consumer. But what is changing now is the source of income for Americans, what we've seen is a shift away from wage and salary income, and we're now seeing a greater reliance on non-labor income that includes things like interest, dividends and rent.
Michael Reid
You know, I'll add to this too. Over the past couple years, consumer confidence really looks awful. It's declined notably. We're seeing wage growth slow, and in particular, in contrast to the boom times, the lower end of the wage spectrum is starting to see their wage growth slow more meaningfully below that of those upper income folks. So that's weighing on them. And then you layer on to that, that shift in prices. We've talked a lot about this. You know, prices are up anywhere from 25 to 30% since 2020 but again, that's not what it feels like for everyone. In fact, we did a study on this, and it's really the low to middle income folks that feel inflation more meaningfully has a bigger impact on their budgets relative to those higher income folks. So, all of this is a recipe right now for consumer confidence, again, that is that is slowing. But importantly, the way to understand that is, when you think about consumer confidence and what it is measuring, it is an equal weight vote of how each person is feeling about the economy, whereas the consumption data is weighted towards income.
Vito Sperduto
As you think about consumption and the consumer, Mike, do you see differences between the different bands? Like, for instance, I know you've written about this, but the millennials seem to be spending less and saving more, which bodes well for the future. But obviously it's less consumption today. You know, are there any notable trends like that to point out?
Michael Reid
Now millennials, I think, are particularly interesting group, because you're right now in that kind of peak home buying period for millennials, and what we've seen is, yes, they've generated a lot of wealth, but it's tied up in their home, so it's a very illiquid asset. Now, what was really interesting in the study that we just released with respect to wealth is the bottom 10% when you look at the share of personal spending. The bottom 10% actually look okay, because that group is heavily reliant on government transfers, and they benefit from colas, so their spending power more or less stays in line with inflation. It's really the middle folks, and I'll even say the 40 to 80th percentiles that are seeing the biggest pinch, they tend to be the groups that get the least amount of government support, you see, kind of a phase out of some of the tax benefits in those cohorts as you approach the 80th percentile, and at the same time, their wage growth just hasn't kept up. Again, looking back to that post covid Boom in wage growth, it was really the lower income folks that saw the biggest boost. So, it's the middle-income folks that are struggling the most. And you know, it's interesting, because you do see that reflected in some of the data. We are seeing a rise in delinquencies for things like credit cards, auto loans and the like. You have student loans coming back into play, and that tends to impact again, those middle income folks, maybe those folks who are newly entering the workforce just getting established, whereas the folks at the upper end of the income spectrum are largely older, more established in their careers, or, you know, even retired now, aren't exposed to that type of Debt and have largely benefited from this higher rate environment.
Vito Sperduto
One of the topics that that you guys have talked about quite a bit is some of the retirement trends, and they're clearly in play. And I know this has shaped how you think about the labor market, for example. So I've heard both of you and Francis say that indicators like the unemployment rate don't mean what they used to. You're forecasting the unemployment rate to rise to 4.6% in ‘26 how should we interpret that, and how should companies rethink labor strategy in a world where unemployment data maybe doesn't reflect the real slack the system.
Michael Reid
There will be some notable shifts over the coming years, but at the end of the day, a four and a half percent unemployment rate is still quite low. Now thinking about the demand side of the equation. This is really where the retirement story comes into play, and that's where you really have to switch the way in which you're interpreting the labor market data as it relates to what's a strong payroll print. And by that, what we mean is, you have to account for the supply of workers, which is really falling. So, when you take into account the immigration story, the slowdown of inflows into the U.S., and on top of that, you think about this retirement story, retirements at the end of the day, subtract from payrolls. And so, when you hire someone to replace a worker who has retired, the net impact on payrolls is zero. So, you still have a lot of hiring going on. So, if in a given month you have 100,000 people retire and you hire 100,000 new workers, the payroll report will say zero. So as the trend in retirements continues to accelerate. And if immigration policy stays as it is, you could see a case where, by 2027 or 2028 you could have a negative payroll print and the unemployment rate won't rise.
Vito Sperduto
What does the early data tell us about whether AI is actually lifting productivity, or is it simply shifting where work happens?
Michael Reid
Right now, what we are seeing is a notable contribution to growth here in the U.S. as a result of AI investment. Now that shows up in various ways. We saw it start with an investment in various structures. So that is kind of creating the buildings in which all of the components for data centers are housed. Then you see an investment in information processing equipment, as well as other types of equipment that helps actually run the data centers themselves. So, you're installing servers, you're installing electrical components, you're installing HVAC systems, and then all of the infrastructure that you need to build out to support that ecosystem. And that creates value along the way. It helps support jobs and the communities in which these data centers are built. But keep in mind, a lot of that value is transitory. That is to say, once you build it, you're not going to have all of those jobs persist over the next year. Can AI really start to impact and pay a dividend in terms of that investment, in terms of productivity, and we still think it's early days for that. We are starting to see a notable shift in terms of the composition of hiring. One occupation that we're watching closely is data scientists and the hiring patterns there. Those folks are the ones we think are going to be most meaningful in terms of how they use AI and where that productivity boost will show up. But it's still a very new occupation.
Vito Sperduto
Do you see AI reinforcing the K-shape economy in terms of where it's impacting the labor force?
Michael Reid
Could it worsen the K? I think, yes. Part of that's already in play when you think about the wealth effect, that's really helping prop up that, that upper percent of income earners, the wealthier households that do have a disproportionate exposure to equity markets, they're benefiting right now, but as you think about some of the dynamics of in particular, the US labor market, AI can help solve some of those problems in many ways, when you think about the falling supply that we are facing again, if the immigration policy stays the same here in the next few years, you're really going to have a very tight labor market as a result of retirements. Anecdotally, you hear about AI kind of replacing some of the research, or helping write briefs, still needing to check it, but you know, very much treating it like an intern, and I think as AI continues to evolve and grow, you can see it graduate to become kind of a more junior employee that you rely on to do certain things, tasks that that may take time away from other areas, and it can certainly augment and boost productivity elsewhere and perform certain functions just faster than a human can. So, it'll help boost productivity in that sense.
Vito Sperduto
Awesome. I'm waiting for the day that it replaces the Head of Capital Markets. So we'll get there soon. Well, Frances just shifting a little bit, you know, not just in the US, but also in Canada, Europe and globally, the idea that big government is here to stay keeps coming up. There are political angles to this, but from an economist standpoint, what does that shift signify?
Frances Donald
Vito, great question, certainly, a very common question that we get regularly, could be in the media, It could be at conferences, is, well, this debt level must be unsustainable. There must be an X date. There must be a moment where it all hits the fan, right? And that is a discussion, and it does matter. But right now, as economists, I spend a lot more time thinking about what are the implications to an economy when government gets larger and larger, because the more work that Mike and I do on demographics, the more that we see, by the very nature of an aging population, a greater reliance on Social Security, and pair that with so much of the focus on infrastructure development, defense productivity enhancements, governments are likely to stay big or get bigger on a go-forward basis. And again, this conversation tends to focus on the United States, but we're seeing similar expansions of the size of government in places like Germany and Canada as well. And in some economies, we've actually seen bond markets reward investment growth in deficits in order to engage in growth-enhancing types of development. So, most of my time is thinking about, what does the US economy look like when government gets larger and larger? And one of the elements, I think, of this is so fascinating, is that government money tends to be acyclical right? So, if the private sector goes into a recession, it doesn't tend to change the amount of spending coming through from governments at the same time. And what that effectively means is that when government is as large as it is, there's likely a floor under the U.S. economy and how weak it can become, but there's also probably a ceiling. We know government spending doesn't tend to be as productive, and particularly if it's biased towards things like social security transfers, it's not generating sustainable upward movements in productivity. So this new type of economy that's developing, one that is increasingly retired, one that is increasingly fragmented, one that is increasingly driven by government spending, to which it is more and more sensitive, tells us that this is a U.S. economy that's probably going to have growth numbers that fluctuate less, that are stuck between smaller bands, and therefore this traditional way of thinking about the business cycle and planning around a business cycle and recessions and troughs, I'm not sure that's as effective as a go-forward basis. So we can talk about the concept of debt sustainability, when it will be politically relevant again to see a cut back on spending. But until then, we should be thinking about, how does our economic framework change when your economy is increasingly tied to government spending, less cyclical than it has been in the past, and has less private sector to drive it? That, to me, is one of the most interesting questions, maybe on a structural trend facing the United States in 2026 and also probably over the course of the next five years.
Vito Sperduto
Yeah, I would have thought that as we got through the pandemic and then some of the other geopolitical issues that are going on, that there would have been a push to have less reliance on government. But we're certainly seeing the opposite of that in many cases, as you just highlighted.
Frances Donald
Well, one of the challenges, and we touched on it earlier, is, what do you do? As Mike described, when you have this sort of K shape developed. In theory, you would want to hike interest rates for the top 10% of Americans, and you should be cutting them for the bottom set of Americans, those in the lowest part of the K. But monetary policy is only one tool that impacts everybody at the same time. And so, part of the big government story is often or is also recognizing that much of the ways that we used to treat ailing economies and hope to boost economies isn't going to function when your economy is more fragmented, when it's less interest rate sensitive, and when you've had persistently high inflation for years and years and years. So, the policy prescription is government spending. So maybe we need to switch away from the idea that you need to spend the least amount as the government as possible and think more about what constitutes a good big government and what constitutes a bad or unhealthy big government. That, to me, is one of the most interesting questions that as economists we can answer.
Vito Sperduto
Well, why don't we wrap this up. You know, we all know every year brings new themes and unexpected challenges. You both spend a lot of time with clients across sectors. What next-chapter themes or risks are dominating those conversations right now. I'd love for you to just pick one that is under appreciated as we enter ’26.
Frances Donald
I'll jump in first so that mike doesn't steal mine. Maybe, you know, so interesting. We just talked about all the themes for 2026, and I think I mentioned the word once, which is tariffs. It's really fascinating to me how little we're talking about this ginormous trade shock that's likely only going to start materializing in 2026. Vito, we talked a little bit about why we see inflation in those that core inflation around mid-threes, some of the challenges coming from tariffs, although not just tariffs, but I think there's still we're walking a very narrow tight rope here. There's some companies that are clearly shedding some jobs in response. There's others that are raising prices so far, this seems relatively well managed, but I don't know that we want to take our eye off the ball of tariff risks just yet.
Michael Reid
So, the one thing that we are increasingly talking about and highlighting is just that risk around a pullback in spending by that upper 10% of income earners and those wealthy households. And you know what might cause that? It wouldn't be unreasonable to think something like a 10% correction in the stock market could give pause to a lot of those folks in terms of that wealth effect. And unfortunately, we just don't have a lot of good data historically on that wealth effect, so it's very hard to quantify. But one thing I've also pointed out, it's not just consumer spending where you have impacts. It also has ramifications for the labor market. If you have folks who are thinking about retiring and maybe look at their portfolio and say, You know what, I want to work another year or two. That has knock-on effects for that replacement demand I mentioned earlier. That means new entrants coming into the labor market may not find a job as easily as they would have if that those folks retired. So, it's it has serious consequences for the labor market as well as consumption.
Vito Sperduto
Well, you know, I will add one to it. And I think an underappreciated risk is the impact of the 2026 election cycle, and how that could come into play in terms of decision making, and how it if it collides with sort of a fragile macro handoff, and as we've just talked about, the greater dependence on government, the greater dependent on policy that's being that is government-driven. And you know, whether it's industrial strategy, energy, technology, some of the reshoring incentives that they've put out there, you know, how do we manage that, especially if there's a dramatic shift that causes the administration to do some certain things, but with that, it's a great point to end on here, and you know thank you both for spending some time, and I always find it incredibly valuable. Thank you.
Frances Donald
Thanks for having us. Vito.
Michael Reid
Thanks, Vito.
Vito Sperduto
Thank you for listening to Strategic Alternatives, the RBC Capital Markets podcast. This episode was recorded on November 19, 2025. Listen and subscribe to strategic alternatives on Apple, Spotify, or wherever you get your podcasts. If you'd like to learn more or continue the conversation, please visit RBCCM.com/strategic alternatives, or contact your RBC Representative. See you on the next episode.
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