‘Two-Speed’ Economy Is a Fed Conundrum

SUMMARY

• The US economy is a conundrum – growth is robust even as consumer confidence is poor.
• We believe this ‘two-speed’ economy is due to tech spending, as well as differing attitudes depending on income level and political affiliation.
• We expect the Fed to continue to cut interest rates due to the uneven economic backdrop.

This fall’s six-week US government shutdown – one of the longest on record – complicated an already confusing economic picture, as data availability from government agencies ground to a halt. The shutdown delayed many September and October data sets while leaving a permanent hole in others.

With the government now back up and running, investors were inundated with ‘catch-up’ data releases over the last week related to employment and inflation… though some important data points such as Consumer Price Inflation (CPI), housing starts, and retail sales will likely not be released until later this month, after the FOMC meets on this week to set interest rate policy.

To make matters more confusing, the picture that emerges from the data fog is a bit of a conundrum: for instance, last week’s releases showed conflicting employment trends, with weak payrolls but stronger initial jobless claims. This compromised data visibility has made a divided Fed’ s job even harder. Regardless, we believe the Fed will cut interest rates 25 basis points on December 10 and are likely to further cut multiple times in ’26.

Underneath the mixed messages sits a ‘two-speed’ US economy that is expanding in aggregate but unevenly, with enough weakness in areas like the lower-end consumer and manufacturing to keep the Fed accommodative, in our view. The parsing of this economic conundrum is worth exploring in more detail, as we attempt to do below.

A Tale of Two Economies, Part I: Tech Spending Red Hot… Non-Tech Spending Only Growing Slowly

Much has been made recently of poor consumer confidence; the widely followed University of Michigan Consumer Confidence poll, while having recovered slightly last month, is still near all-time lows, going all the way back to the index’s launch in 1953. This comes despite a low unemployment rate of 4.4% and relatively strong economic growth.

The Atlanta Fed’s GDPNow forecasting model suggests the US economy, while slowing some from its’ earlier torrid pace, likely grew above a 3% rate in Q3 (Chart 1, above). This suggests an economy that’s far from recessionary. But it begs the question of why consumer and manufacturing sentiment can be so low right now if the economy is still expanding.

We think the first step to better understanding this ‘two-speed’ economy is to try and quantify just how much of the economy’s 2.1% growth in Q2 was driven specifically by tech spending, due to capital expenditures related to AI and cloud investment.

Using 2nd quarter data on investment in software and information processing equipment from the US Census, we believe tech spending now represents ~6% of US GDP – the highest percentage on record. Tech spending is also growing at a red-hot rate of close to 17% year-over-year (Chart 2, above right). Once you back out this contribution, it suggests that 0.8% of the 2.1% GDP growth rate in Q2 is due to tech…suggesting the economy ex-tech spending is only growing at a sluggish ~1.3%. Massive ongoing AI investment helps explain why an economy showing strong top-down growth can seem depressed at the same time, particularly when you focus on non-tech related areas. For instance, sectors such as housing and manufacturing continue to struggle, disrupted by uncertainties around tariffs, inflation, and interest rates.

A Tale of Two Economies, Part II: Low Consumer Confidence Biased Downwards by Income and Politics

Parsing consumer sentiment data in more detail also reveals some fascinating nuances. Specifically, we believe consumer confidence varies widely by income level and by political affiliation, as illustrated by two separate consumer sentiment polls – the Conference Board’s Consumer Confidence data (Chart 3, right), which breaks the data down by income levels; and the before-mentioned University of Michigan Index of Consumer Sentiment, which divides up confidence levels by political affiliation. Perhaps not surprisingly in an economy marked by sustained inflation since 2020, high earners have much higher confidence than lower ones (Chart 3). This is an important distinction for both the economy and the stock market, as high earners tend to own the majority of financial assets and disproportionately drive overall consumer spending.

Also, not surprising in a country marked by deep political divisions, consumers who identify as Democrats or Independents have much lower confidence than those who are Republicans (Chart 4, below). These consumers are living, working and spending in the same economy, but it can feel quite different depending on your confidence in current policymakers.

CONCLUSION: Enough Controversies in the Economy to Keep Fed Engaged in ’26; Stocks Should Benefit

From a 10,000-foot view, the US economy is expanding… and we suspect it will continue to do so over the next 12 months. However, whether you work in tech or not – and where you find yourself on the socio-economic and political spectrum - clearly influences on how you are experiencing this economy as a consumer and as a worker. This ‘two-speed’ economy – robust for tech-related industries and high earners, and slow or even recessionary for others – is clearly very uneven. We believe this may force the Fed to continue to prioritize the job market over curbing inflation - suggesting more interest rate cuts over the next 6-12 months, even as inflation remains stubbornly above the Fed’s long-term target of 2%. A backdrop of economic expansion with enough economic controversy to keep the Fed engaged is a pretty constructive backdrop for owning stocks, in our view…even if it causes economists to scratch their heads. RiverFront remains overweight US stocks relative to bonds in our balanced portfolios.

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