2026 U.S. Economic Outlook

Navigating Policy and Market Shifts

As the year draws to a close, our focus at Dillow Wealth Management turns to planning for the year ahead. We've reviewed Morgan Stanley's 2026 Economic Outlook, and I wanted to share the key takeaways that could shape our financial environment.

The outlook suggests a complex picture as the economy emerges from a period of policy uncertainty, with the following highlights:

Growth & Labor Market

• GDP: Expect a challenging start to 2026 with the economy at its weakest in late 2025 and early 2026. However, growth is forecast to recover as the effects of policy shocks begin to fade.

• Labor: Employment growth is expected to slow significantly, averaging 55-60k per month in 2026-27. The unemployment rate is projected to peak at 4.7% in Q2 2026 before falling back to 4.4% by the end of 2027. Slower labor supply growth, constrained by immigration controls and an aging population, is a key factor here.

Inflation

• Tariffs: Tariff-induced rises in goods prices are expected to push headline and core PCE inflation higher through early 2026 (up to 2.9% and 3.1%, respectively). These effects are anticipated to be transitory.

• Moderation: Inflation should begin to decelerate as the tariff push fades and the labor market cools.

Monetary Policy

• Rate Cuts: The Federal Reserve is anticipated to deliver three 25-basis-point rate cuts, reaching a terminal target range of 3.0-3.25% by April 2026, as a softer labor market increases confidence in transitory inflation.

• Policy Debate: The Fed remains divided, with "hawks" concerned about asset markets and AI spending, and "doves" focused on weak labor demand and a softer consumer.

Fiscal Policy

• Deficits: Large fiscal deficits are expected to persist, driven by the One Big Beautiful Bill Act (OBBBA), which front-loads deficits into the near term.

• Growth Support/Drag: Fiscal policy is forecast to support growth in 2026 and 2027 but poses a future drag risk if entitlement spending cuts take effect and tax cuts are allowed to expire later on.

Consumption, Wealth, and AI

• Consumption: Real income growth is expected to slow near term, weighing on spending, but personal consumption expenditures should improve as 2026 progresses, supported by a fiscal boost and recovering real labor income.

• Wealth: Household net worth is up significantly since 2019, though the benefits are disproportionately accruing to high-income consumers, leading to a "K-shaped" economy.

• AI Investment: Investment in AI is surging, but its contribution to GDP growth is less than headline numbers suggest, as much of the spending is in intermediate goods and imports. Significant AI-driven productivity gains are expected after 2030, with modest gains in 2026-27.

This outlook gives us a solid framework for understanding the macro environment we'll be navigating. As always, the key is to ensure your personal financial strategy is resilient and adaptable to these evolving conditions.

If you have any questions about how this economic forecast impacts your specific investment plan, please reach out.

Best regards,

Tim Dillow, CFP(r)

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