USD: Why the bifurcated economy defies recession calls
For the past three years, economists, analysts, and CEOs have played a familiar game: “Recession next year.” Each January begins with strong conviction that the data will confirm it, only for consensus to shift by late fall: “Definitely next year.” As Nobel laureate Paul Samuelson once quipped, “Nine of the last five recessions have been predicted by economists.” If you call for a downturn long enough, you’ll eventually be right. But as of now, the odds of a broad-based, traditional economic contraction remain surprisingly low.
That said, the atmosphere entering the latter half of the year feels distinctly different. We began with a narrative of an extraordinarily resilient U.S. economy, where the labor market held firm despite the Federal Reserve’s fastest hiking cycle since 1982. But now, cracks are emerging. Even the Fed has acknowledged that the labor market is at a near standstill.
To understand the present, we must first recognize that the idea of a singular, monolithic “U.S. economy” is outdated. We are now living in a bifurcated economy.
Historically, economic cycles were relatively uniform. Improvements in GDP growth, employment, and consumer sentiment typically signaled better conditions for most households. But the post-COVID era shattered that synchronicity, giving rise to what economists now call a K-shaped recovery, a divergence where one segment of the economy rebounds or thrives, while another continues to stagnate or decline.
The most visible split is between high-income and low-to-middle-income Americans. High-income households have been the primary beneficiaries of the current financial landscape. They’ve earned more on savings thanks to elevated interest rates and seen substantial wealth gains from surging stock and housing markets. In contrast, low- and middle-income households have missed out on these asset gains and have borne the full brunt of persistent inflation, especially in non-discretionary categories like rent and food. As pandemic-era stimulus dried up, many in this group have depleted their savings and increasingly relied on credit to maintain consumption.
This divergence is not anecdotal, it’s well-documented:
- Labor market divergence: A 2021 working paper from the U.S. Bureau of Labor Statistics found that high-wage, remote-capable jobs rebounded quickly, while sectors like hospitality and leisure, which employ lower-income workers, struggled and faced lasting instability.
- Sectoral disparity: Industries such as technology, finance, and professional services have thrived, while high-contact sectors reliant on physical presence have lagged. Economic research describes this as a form of “creative destruction” accelerated by the pandemic.
- Consumption polarization: A recent Moody’s Analytics analysis found that the top 10% of U.S. households, those earning roughly $250,000 or more annually, now account for nearly 50% of all consumer spending, the highest share since records began in 1989.
This means aggregate consumption data can be structurally misleading. When high-income households continue to spend lavishly on luxury goods, high-end travel, and large-ticket investments, it can mask the financial distress experienced by the bottom 90%.
So how can the U.S. economy be tracking toward a healthy 3.9% growth rate in Q3, according to the Atlanta Fed’s GDPNow model, while the labor market is clearly softening? The economy is showing “no-hire, no-fire” signals.
- No-fire: Employers remain hesitant to lay off staff after the post-pandemic hiring challenges, keeping the layoff rate low.
- No-hire: Hiring has slowed significantly, with new job creation largely confined to non-cyclical sectors like healthcare and education, essential services, but not engines of long-term productivity or industrial expansion.
- AI-driven productivity: Companies are investing heavily in capital expenditure on AI and technology, enabling them to grow revenue and profits without significantly increasing headcount. This is becoming the new engine of corporate profit and GDP growth, even as the jobs market cools.
Meanwhile, markets remain buoyant, seemingly detached from the underlying economic divergence. Several factors explain this disconnect:
- Record corporate profits: Corporate profits have surged, benefiting disproportionately from the AI CapEx boom.
- Wealth effect spending: Investment valuations are driving the wealth effect, pushing the top-half of households to spend, vacation, and spend.
- Monetary and fiscal clarity: The Fed is continuing its normalization path, and market expectations are settling around the administration’s new economic agenda, particularly the deregulation agenda.
Ultimately, the question of whether a recession is imminent, in the U.S. or globally, is no longer just about cyclical indicators. It’s about structural inequality. The current economy is a high-wire act, where the resilience of aggregate data masks the fragility of the median American. The health of the system now rests on the continued willingness of high-income consumers to spend; a behavior increasingly tied to the volatile fortunes of the stock and housing markets.
EUR: Treading water at 1.16
Euro price action was relatively quiet yesterday. EUR/USD tested support at 1.1580, before remarks from Lagarde helped the pair reclaim the 1.16 handle. While not materially market-moving – offering little in terms of forward guidance – what stood out was her echoing of German Chancellor Friederich Merz’s call for a single European stock exchange to support listings and drive economic growth.
Lagarde commented, “if we are serious about moving forward, we must complete the banking union – and we must apply the same logic, and faster, to capital markets: a single rulebook, a single supervisor, and a consolidation of exchanges.”
The remarks come at a time when recent developments – France’s government collapse and rising trade tensions with the US – have underscored one of the eurozone’s core vulnerabilities: fragmentation. In fact, euro sentiment continues walking a tightrope, and remarks alone offer little to support a more sustained uplift.
Meanwhile, ramped-up pressure on Russia from Trump – including sanctions on its largest oil producers – sent oil prices sharply higher. That’s no good news for the euro: as a net oil importer, the euro area faces deteriorating terms of trade when oil rises, often prompting increased euro selling to purchase USD-priced crude, which can weigh on the currency. That said, with WTI still down 3.7% month-to-date, the jump had limited FX reaction.
For today, keep an eye on France’s INSEE business and manufacturing confidence figures – leading indicators worth watching as we assess whether political uncertainty has already clouded the economic outlook. Consumer confidence for the broader bloc is also due.
GBP: Sterling softens, as cuts creep in
Markets aggressively priced in rate cut expectations following yesterday morning’s inflation data, which showed signs of softening. December meeting’s pricing jumped from 10 basis points to 18. The move explained sterling’s sharp underperformance against major peers – falling 0.5% against the dollar before bouncing off support at 1.33, paring back some losses.
A reinforced easing bias now adds to the gradually intensifying fiscal stress ahead of the Autumn budget, leaving sterling more vulnerable to sell-offs. We see these as the two defining bearish forces for the currency in the months ahead.
Markets will continue monitoring macro indicators closely, with further cuts likely to be priced in if other parts of the economy – especially the labour market – show continued signs of softening. Remember, the Bank of England is more concerned with demand-driven inflation, which tends to be stickier than supply-side pressures. As wage growth moderates – ticking lower, as we saw last week (though still elevated), the likelihood of reduced price pressures, via services, increases, reinforcing the case for further easing.
For the rest of the week, retail sales and PMIs tomorrow will also be worth watching as a gauge of consumer demand and broader economic momentum. We don’t yet see short-term catalysts to justify a breach below 1.33.
Oil jumps on fresh sanctions
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Calendar: October 20-24
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