Economic Boom Or Crash Next? Turning Point Reached | Bloomberg’s Anna Wong

Key Concepts

• Economic Recovery: The current state of the economy is seen as being in a recovery phase, with various indicators showing a rebound.
• 2026 Economic Outlook: Optimism for 2026, with expectations of the economy "firing on all cylinders."
• Five Tailwinds: Specific factors contributing to the optimistic economic outlook.
• Labor Market: Analysis of hiring trends, including the impact of the birth-death model and alternative data sources.
• Recession and Double Dip: The hypothesis that a recession occurred in the previous year and potentially a "double dip" due to policy shocks.
• Trade Policy Uncertainty: The impact of trade policies on investment and economic activity.
• Fiscal Impulse: The effect of government spending and taxation on economic growth.
• Financial Conditions: The role of financial markets and the Federal Reserve in influencing economic activity.
• Artificial Intelligence (AI): The dual impact of AI on capital expenditure and labor productivity.
• Cyclical Recovery: The natural rebound of economic activity after a period of contraction.
• Credit Cycle: The behavior of delinquencies and the potential risks in the credit market.
• K-Shaped Economy: The divergence in economic fortunes between different income groups.
• Inflation: Projections for inflation and the Federal Reserve's tolerance for higher inflation.
• Federal Reserve Reaction Function: The observed shift in the Fed's approach to monetary policy.
• Tariffs: The impact of tariffs on import prices, consumer prices, and profit margins.
• Credit Market Risks: Potential systemic risks stemming from the private credit market.

Economic Recovery and Optimistic Outlook for 2026

The economy is currently in a recovery mode, with many indicators showing a bounce back. The speaker expresses optimism that 2026 will be a year where the economy is "firing on all cylinders," driven by five key tailwinds.

Anna Wong's Shift in Economic Outlook

Anna Wong, Chief US Economist at Bloomberg Economics, has shifted from a previously bearish stance on US economic growth prospects to an optimistic one. Her prior bearishness in 2023-2024 was primarily due to her interpretation of the labor market data. She argued that a direct reading of non-farm payrolls was misleading due to overstatement from the birth-death model, suggesting weaker underlying net hiring.

Evidence for Shift:

• Benchmark Revision: Preliminary benchmark revisions from the Bureau of Labor Statistics (BLS) indicated that job statistics in 2024 might need to be revised down by 911,000.
• Recession Hypothesis: Wong posits that if the labor market was indeed not hiring and experienced negative job prints last year, a recession may have already occurred. This implies the economy should now be in a recovery mode.
• Double Dip Theory: She suggests a recession started last year and entered a "double dip" this year, exacerbated by policy shocks from the Trump administration's trade policies. The tariff shock alone is estimated to have caused a 1 percentage point fiscal contraction.
• Trough Activity: The lowest point for economic activity is estimated to have been around June of the current year, with a subsequent rebound observed in various statistics.

Five Tailwinds Driving Optimism

Wong outlines five specific tailwinds contributing to the positive economic outlook:

1. Trade Policy Uncertainty:

   • Key Point: Trade policy uncertainty peaked in the first quarter of the current year and has been sharply declining since.
   • Impact: The peak drag from trade policy uncertainty is estimated to last 3-4 quarters. The subsiding uncertainty is expected to unleash pent-up investment by mid-next year.
   • Technical Term: Fiscal Contraction: A reduction in government spending or an increase in taxes that slows down economic activity.

2. Fiscal Policy:

   • Key Point: While tariffs caused a 1 percentage point fiscal contraction this year, a "big beautiful bill" is projected to generate a 0.4 percentage point expansionary fiscal impulse by the second quarter of next year.
   • Technical Term: Fiscal Impulse: The effect of fiscal policy on aggregate demand. A positive fiscal impulse stimulates the economy.

3. Financial Conditions:

   • Key Point: The Federal Reserve's theoretically constructed financial conditions index, measured in units of growth impulse, indicated a 0.5 percentage point growth impulse as of the end of August. Financial conditions have eased further since then, potentially generating a growth impulse of up to 1 percentage point next year.
   • Drivers: This easing is attributed partly to the AI boom and significantly to the Federal Reserve's accommodative stance.
   • Technical Term: Financial Conditions Index: A measure that combines various financial market variables to assess the overall ease or tightness of financial conditions.

4. Artificial Intelligence (AI):

   • Key Point: AI is a significant factor, driving both increased capital expenditure (capex) by hyperscalers and adoption of AI tools by large firms.
   • Impact on Capex: Announced plans suggest AI-related capex could positively contribute to GDP throughout 2026.
   • Impact on Labor Market: Large firms adopting AI are experiencing slower hiring and improved labor productivity. This could lead to higher unemployment in the short term, which would keep the Fed from raising rates even if inflation rises above 3%. This is seen as a "productivity and AI story" causing subpar labor market conditions in the short term.
   • Reinforcement: This scenario reinforces expectations of rate cuts, which is beneficial for investment and AI capex.

5. Cyclical Recovery:

   • Key Point: The economy is experiencing a natural cyclical recovery after 2-3 years of supported activity.
   • Evidence:
     • Business Formation: Business formation is surging, with many new businesses related to AI, indicating an exit from recession or entry into a new business cycle.
     • Credit Cycle: Delinquencies on credit cards, consumer loans, and auto loans have peaked and are falling, suggesting the worst of the credit cycle is over. These rates typically peak during recessions and fall after they end.

Inflation Outlook and the Federal Reserve's Role

• Inflation Projections: Core PCE inflation is forecast to hit 3.0% at the end of the current year and trend upwards to about 3.3% by the end of next year.
• Fed's Reaction Function: Wong's re-estimation of the Fed's reaction function suggests a dovish shift, with the Fed appearing to tolerate inflation permanently higher than 2%, possibly embracing the "transitory inflation" argument again.
• Fed's Tolerance: The Fed is expected to accommodate inflation up to a little above 3%, especially if the unemployment rate continues to trend upwards. This is linked to the AI's impact on reducing hiring.
• Future Rate Hikes: The Fed is projected to hike rates in 2027 as inflation exceeds 3.3% next year. However, they would still be inclined to cut rates when inflation is around 3% (1 percentage point above their target) if the unemployment rate is climbing.
• Dovish Pivot Timing: The dovish tilt in the Fed's reaction function began in mid-2024, coinciding with the trough of inflation. This pivot preceded any potential influence from Trump.
• Rate Cuts: By the end of the current year, there are expected to be 75 basis points of rate cuts.

Turning Decisively More Bullish

Wong became decisively more bullish due to:

1. Labor Market Bottom:

   • Data Source: Reliance on alternative data provider Homebase for job estimates, which has been accurate.
   • Observation: For the last 4-5 months, Homebase data has been consistently more optimistic than official non-farm payrolls, suggesting small businesses are recovering from a "blue period."

2. Economic Modeling:

   • Observation: All five identified tailwinds reflect economic modeling, and negative shocks to growth this year have been absorbed.
   • Historical Context: It's rare for negative GDP growth or recession to last beyond three quarters, even during financial crises. The current weakness started around April/May of last year and extended through the fourth quarter, with another shock in the second quarter of this year. This suggests a strong recovery force, especially with the Fed's apparent unwillingness to be hawkish.

K-Shaped Economy and Consumer Spending

• Divergence: The economy exhibits a K-shaped pattern, with the top 20% of households (stock owners) benefiting from the rally, while the bottom 50% struggle with student loans, car loans, and high grocery prices.
• Government Transfers: Government transfers that consumers relied on during the Biden administration are diminishing, and student loan repayments are resuming, potentially leading to wage garnishment.
• Systemic Risk: Wong views the struggles of the "have-nots" more as a financial stability risk rather than a direct drag on GDP growth.
• GDP Drivers: GDP growth is currently driven by investment (AI investment) and the wealth effect.
• Consumer Spending: Consumers are not spending on discretionary travel and goods, as indicated by the struggles of Airbnb.
• Credit Issues: Problems with companies like Tricolor and First Brands, related to subprime auto loans, are seen as "cockroaches" but not systemic enough to derail GDP growth.
• Auto Delinquencies: The most predictive factor for auto loan delinquency is the monthly payment size. Used car prices rose significantly between 2020-2022 and have since fallen. Borrowers in 2023-2024 have better credit scores than those who bought cars in 2021-2022. Auto delinquencies are believed to have peaked.

Resilience of the Economic Boom

The resilience of the economic boom depends on whether the top 20% continue to spend. If they rein in spending due to a stock market downturn, it could impact GDP growth. However, Wong believes that as long as the Fed continues to cut rates, this K-shaped economy can sustain itself.

• Inequality and R-star: Inequality can lead to a lower "R-star" (natural rate of interest) because wealthier individuals have a lower marginal propensity to consume and save more. This concentration of savings in the wealthy could lead to higher national savings rates.
• Fed's Dovish Posture: The Fed's adopted dovish posture, even if excessively so, is seen as a key factor enabling the economy to continue.

Revised Unemployment Rate Forecast

The unemployment rate forecast has been lowered from 5% to 4.4% for Q1/Q2 of next year. Reasons for this revision include:

1. Immigration Crackdown: A larger-than-expected immigration crackdown has tightened the labor market.
2. Wealth Effect and AI Boom: The AI boom's contribution to GDP growth (1 percentage point of 1.6% average growth in H1) has been larger than anticipated.
3. Fed's Capitulation: The Fed has capitulated faster than expected, shifting its reaction function in a dovish direction. Wong previously believed the Fed would hold rates higher for longer due to fears of tariff-driven inflation.

Impact of Tariffs

• Pass-Through: Importers bear almost 95% of tariff costs. For every $1 increase in tariffs, consumer prices increase by about $0.30, meaning 70% of the cost is absorbed by intermediate firms through profit margin compression.
• Pricing Power: Firms' pricing power is limited by consumer income shocks. Better pricing power is expected during economic recovery when consumers are more willing to spend.
• Future Impact: The full impact of tariffs is yet to be seen, and firms may attempt to pass on these costs next year and beyond, especially if the economy is strong.

Factors That Could Lead to a More Bearish Outlook

Wong would become more bearish if:

1. Credit Market Shocks: The key unknown is the credit market. While current data on auto delinquencies is reassuring, private credit is a "shadowy corner." A credit market event could lead to a stock market crash and wider contagion.
2. Federal Reserve Policy Mistake: If the Fed fails to respond adequately to market events or is too slow in its response, it could exacerbate a crisis. The Fed's quick liquidity provision during the Silicon Valley Bank collapse is cited as an example of effective intervention. The Fed's response is crucial, and a sudden hawkish turn by the Fed, absent a shockingly high inflation print, would be a significant concern.