The long run: AI leads, incomes cool, risks linger
May 27, 2026
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2 min
May 2026 highlights
I Can’t Tell You Why: Nominal growth has been remarkably stable over the past few years despite the myriad shocks the economy has faced, but the same cannot be said for nominal incomes which have continued to slowly cool on the back of labor markets that have remained mired in a no hire, no fire stasis. While wealth effects certainly appear to be playing a material role in supporting resilient consumption, that divergence between incomes and spending can only persist for so long. With real incomes now getting squeezed further by the energy shock that divergence looks likely to resolved with nominal growth catching down to cooling nominal incomes.
Hotel California: The market narrative has been stuck between a closed Strait and an AI boom, but it’s abundantly clear which one of those is winning at the moment. AI-related CapEx spending continues to surge, with that spending now responsible for contributing nearly 90 basis points to GDP growth on average over the past five quarters, surpassing even the highs printed during the dotcom boom. The narrative has swiftly shifted and a positive feedback loop has now taken hold with fears of declining free cash flow and unknown ROIs relegated to the history books. Model advancements are validating the massive spend and continuing to support not only robust CapEx spend but earnings growth and equity markets more broadly.
Take It Easy: Much ink has been spilled debating the falling breakeven rate of payrolls growth required to keep the unemployment rate from rising further. But another breakeven rate has flown under the radar: the breakeven rate of jobless claims that translates to employment growth. While claims have been impressively well behaved and fallen further this year, bolstering the labor market reacceleration narrative, the breakeven rate for claims has been falling as well. Indeed, claims remain below that breakeven rate, the spread between jobless claims and the breakeven rate appears to be more evidence confirming a stabilization in labor markets, but not quite an outright reacceleration.
Lyin’ Eyes: The manufacturing sector is another pocket of the economy where the reacceleration narrative has taken hold. Manufacturing related data has certainly firmed to kick off 2026, whether that’s manufacturing PMIs, industrial production, or manufacturing employment. But don’t conflate an inventory restocking cycle with a true cyclical reacceleration. Stabilization is certainly welcome, and has been key to supporting the stabilization in labor markets, but inventory restocking cycles don’t last forever, and that means the bounce in the manufacturing sector may prove to be fairly short-lived once those inventories are rebuilt.
Already Gone: The Fed’s easing bias is on borrowed time. Downside risks to the labor market have abated as conditions have stabilized while upside risks to the inflation side of the Fed’s dual mandate have only increased. Unsurprisingly, the Fed is well on its way to a more neutral stance on policy, while markets have outright priced in a modestly hawkish reaction function. But while market participants and FOMC members alike scramble to outhawk each other, underlying inflation trends remain more encouraging as nominal incomes continue to soften and productivity growth holds firm. Inflation risks are certainly skewed to the upside in the near term, but the bar for hikes remains high. Hawkish jawboning, and not outright hikes may prove to be the Fed’s most powerful tool in the coming months.
