Podcast Summary: Thoughts on the Market – “What’s Driving U.S. Growth in 2026”

Host: Michael Gapen, Chief U.S. Economist, Morgan Stanley
Date: November 25, 2025

Episode Overview

Michael Gapen presents Morgan Stanley’s U.S. economic outlook for 2026, outlining key forecasts for growth, inflation, jobs, and the Federal Reserve’s likely moves. The episode explores the aftermath of intense policy changes, the moderating trajectory of inflation and growth, and the implications of technology and policy risks for the U.S. economy in 2026 and beyond.

Key Discussion Points & Insights

1. Recap: 2025—A Year of Policy Upheaval

• 2025 was characterized by “fast and furious policy changes,” especially around trade and immigration (00:18).
• The impact: Slow growth and sticky inflation, as previously predicted by Morgan Stanley.

2. Economic Outlook for 2026 & 2027

• Growth:
  • Return to “modest growth”—GDP forecast at 1.8% in 2026 and 2% in 2027 (00:35).
  • The economy is “finally moving past the high uncertainty phase.”
• Inflation:
  • Headline PCE inflation at 2.5%, core inflation at 2.6% in 2026, both above the Fed’s 2% target through 2027 (00:45).
  • The “inflation fight isn’t over, but the worst is behind us.”
• Overall Theme:
  • Shift from “slow growth and sticky inflation” (2025) to “moderate growth and disinflation” (2026–27) (01:05).

3. Policy Impact and Risks

• Effects of “strict trade and immigration policies” are expected to fade, improving the economic climate (01:15).
• Tariffs:
  • Still a near-term risk, possibly pushing prices higher for consumers (01:23).
  • If firms cannot pass on costs, risk of layoffs rises.
  • “Tariffs will keep prices firm in the first half of 2026, squeezing purchasing power for low and middle income households.” (02:10)

4. Consumer and Labor Market Trends

• Consumption:
  • Real consumption forecast to rise 1.6% in 2026 and 1.8% in 2027 (02:25).
  • Recovery led by upper income consumers; low/middle incomes see constraints due to higher prices and slow job growth.
• Jobs:
  • Labor market in “low hire, low fire mode,” due to lingering immigration controls and tariffs (02:32).
  • Unemployment projected to peak at 4.7% in Q2 2026, then moderate to 4.5% by year-end (02:40).
  • “Jobs are out there, but the labor market isn’t roaring.”

5. Federal Reserve Strategy

• The Fed is “cutting rates, but at a cost” (03:00).
• Expect two 25 basis point cuts in Sep/Oct 2025, and another 75 basis points through mid-2026, for a total target range of 3–3.25% (03:07).
• Purpose: To “insure against labor market weakness,” even though that means inflation stays above target.
• Tightrope Metaphor:
  • “The Fed is walking a tightrope. Lean too far towards jobs and inflation lingers. Lean too far toward inflation and growth stumbles. For now, the Fed has chosen the former.” (03:25)

6. The Role of AI in Growth and Productivity

• AI “definitely a major growth driver,” boosting GDP by ~0.4% in both 2026 and 2027—about 20% of total growth (03:42).
• Net impact diluted by imported tech; AI’s net contribution declines after imports considered (03:52).
• Long-term: AI is forecast to raise productivity by 25–35 basis points, “planting the seeds now for bigger gains later.”

7. Risks to the Outlook (04:10)

• Three Key Risks:
  • Demand Upside: Fiscal stimulus and business optimism could push growth higher, risk of renewed inflation, and possible reversal of Fed cuts.
    • “If the economy really picks up, then the Fed may need to take back the risk management cuts it’s putting in now.”
  • Productivity Upside: AI could deliver greater-than-expected productivity; could accelerate disinflation and prompt lower rates.
  • Downside—Mild Recession: Tariffs and tighter policy may bite harder, pushing GDP negative in early 2026, with the Fed slashing rates closer to 1%.

Notable Quotes & Memorable Moments

• “If 2025 was the year of Fast and furious policy changes, then 2026 is when the dust settles.” (Michael Gapen, 00:13)
• “The inflation fight isn’t over, but the worst is behind us.” (Michael Gapen, 00:48)
• “US Consumers start to rebound, but slowly. Tariffs will keep prices firm in the first half of 2026, squeezing purchasing power for low and middle income households.” (Michael Gapen, 02:10)
• “Jobs are out there, but the labor market isn’t roaring.” (Michael Gapen, 02:45)
• “Think of it as the Fed walking a tightrope. Lean too far towards jobs and inflation lingers. Lean too far toward inflation and growth stumbles. For now, the Fed has chosen the former.” (Michael Gapen, 03:25)
• “AI is planting the seeds now for bigger gains later.” (Michael Gapen, 04:00)
• “2026 looks to be a transition year with less drama but more nuance as growth returns and inflation cools, while AI keeps rewriting the playbook.” (Michael Gapen, 05:20)

Important Timestamps

• 00:00 – Introduction and context for 2026 outlook
• 00:35 – GDP and inflation forecasts
• 01:15 – Fading impact of trade and immigration policies
• 02:10 – Consumer and labor dynamics amid tariffs
• 03:00 – Fed policy: rate cuts and balancing risks
• 03:42 – AI’s economic impact explained
• 04:10 – Major risks to the 2026 outlook
• 05:20 – Summary: 2026 as a transition year

Summary Takeaway

2026 is expected to be a year of transition and stabilization for the U.S. economy after a turbulent 2025. Look for modest growth, persistent but easing inflation, a cautious Fed, and productivity seeds sown by AI. Tariffs remain an important risk, and the interplay of growth, jobs, and inflation will keep policymakers and investors watchful as the U.S. moves toward a more nuanced economic phase.