How should we interpret the signals coming from both markets and the economy?
Vito Sperduto: The interest rate backdrop remains a key source of uncertainty, with markets closely watching for any shift in policy direction. Equity and bond markets continue to anchor attention, with equities still hovering near all-time highs. Global M&A volume is up nearly 30% year over year. So while there are bright spots, this is the real-time environment we’re navigating.
Frances Donald: The U.S. economy is in what I'd call “stagflation lite.” Growth is running slightly below the comfort zone, and inflation slightly above it. I believe we’re now at risk of seeing both sides move in the wrong direction.
Over the past year, we've been building a framework to better understand what's driving this “stagflation-lite” setup and whether a return to more traditional economic models is likely. What we’ve found is a series of sizable disruptors to the U.S. economic cycle, shifting us away from early-, mid-, and late-cycle dynamics toward a more fragmented, less predictable economy.
What are the five key disruptors RBC Economics has identified?
Frances Donald: These are tariffs, the K-shaped economy, labor supply shifts, big government spending, and housing. Each one is distorting the cycle in a different way, and together, they’re changing how we need to think about the U.S. economy. Will tariffs have a short-term or long-term impact on economic performance?
Will tariffs have a short-term or long-term impact on economic performance?
Frances Donald: There's a tendency to think of tariffs as being a short-term disruption. However, in our view, it could be many years before inventories get back towards a normal cycle, and before traditional import behavior returns.
During the pandemic, it took nearly five years for inventory dynamics to return to a more natural cycle. Even looking at what's unfolded since “Liberation Day” on April 2, we expect those shocks to remain disruptive well into the medium term. That’s because even if the tariffs disappeared tomorrow, the tariff impact wouldn’t.
A bigger challenge is timing. It's unclear when tariff impacts will actually show up in the economy. Tariff revenue has already been collected, but the key question is: who’s going to absorb that cost? The answer will have a significant impact on where the U.S. economy goes in the next one to two years.
If it's passed on to consumers, inflation will rise. But if businesses choose to absorb some of that shock, that’s not a painless outcome either. They’ll need to offset the pressure—whether through efficiency gains, productivity improvements, or cuts to America’s largest business expense, which is labor costs.
“There’s a tendency to think of tariffs as being a short-term disruption. However, in our view, it could be many years before inventories get back towards a normal cycle.”
Frances Donald, RBC Chief Economist
How do you define the K-shaped economy, and why does it make forecasting even more difficult?
Frances Donald: The K-shaped economy, which is very disruptive, is the result of the segmentation and fragmentation that's occurred across the U.S. in recent years.
There’s a growing split in the household environment. High-income households remain relatively insulated, supported by savings and stock market gains, while low-income households are being squeezed by rising financing costs, growing credit delinquencies, and rents outpacing wages.
Prior to 2023, high- and low-income households typically moved in the same direction—when one did well, so did the other. But following sharp rate hikes and a stock market surge, that link broke. High-income households saw strong gains, while low- and middle-income households entered a different cycle, with consumer spending data flatlining.
This divergence is distorting how we interpret the data. If you're leaning too heavily on outcomes for high-income households, you risk misreading where the broader economy is headed.
The labor market is not a new indicator—so why is it considered a disruptor right now?
Frances Donald: We're big believers in this third structural dynamic. America needs workers. And the labor market's biggest challenge in the next several years is not going to be the shortage of jobs, but the shortage of people available to do those jobs.
Non-citizen labor force participation rates are in decline but what we think is more impactful is the mass retirements we’re seeing. Retirements in the U.S. are accelerating very sharply. 2.2 million people retired in the past 12 months, which is the most ever recorded. This is much more than the linear trend we would expect, and much more than many of our clients’ models had anticipated.
The issue is that this we have fewer and fewer Americans able to work, and that isn't reflected in the underlying data.
“2.2 million people that retired in the past 12 months, which is the most ever recorded.”
Frances Donald, RBC Chief Economist
How do you weigh the stabilizing effect of government spending with the long-term risks of debt sustainability and market distortion?
Frances Donald: There’s been a lot of focus on big government spending, but less attention on how it’s shaping the broader economy. On one hand, it puts a floor under growth. On the other, it limits how fast the economy can expand over time.
When spending is this large, it becomes mathematically harder to generate two consecutive quarters of negative GDP—making a formal recession more difficult to trigger. There’s simply so much fiscal support in the system that the private sector's role becomes relatively smaller.
It’s also important to remember that government spending is largely a-cyclical—arguably even countercyclical—often rising as the economy weakens.
Another critical factor is how much of the U.S. economy is tied to the belly and long end of the curve. As concerns around fiscal sustainability push long-term yields higher, large segments of the economy are effectively being held hostage by the move in rates.
Housing is also one of the key dislocations. How is it complicating the outlook?
Frances Donald: There is a housing market dichotomy at play right now. In the U.S., housing has long been leveraged to the long end of the curve, but we’ve seen a major shift. The market is now effectively frozen in a multi-year recession. It has become, in many ways, a lost growth engine.
That’s highly disruptive to many of our economic models, because housing has historically led the cycle. It hasn’t done that this time, and it may not in the next one either.
What do these themes mean for the U.S. Economic cycle?
Taken together, these stories point to a deeper shift in how we need to think about the economic cycle. Many of these dislocations have a slow-burning inflationary tilt, pushing prices up over time. They also reflect the reality that we’re no longer dealing with one unified economy, but multiple economies moving at different speeds underneath the surface.
We see these as core themes for the U.S.—not just over the next five years, but also in the next three to six months, as the economy moves through this stagflation-lite environment.
What concerns me most isn’t a major spike in inflation or a sharp drop in growth. It’s this in-between state where growth is never quite strong enough, and inflation is always just a little too high. This kind of environment makes forecasting harder, policy less effective, and business decisions more complicated.
That’s why the RBC Economics team is focused on earlier signals like producer prices, import costs, corporate earnings, and M&A activity. If you wait for CPI, it’s already too late. I no longer believe that the most interesting and important elements of this market or the economy lie in a forecast table anymore. It’s in the details happening beneath the surface.
