Broadening Boom

More on the K-shaped labor market, the risks to global trade rebalancing, investors are all in on broader, more robust growth but the data is unconvincing making us nervous

Our portfolio had a banner week, but the text of this week’s note is somewhat cautious. When everything starts working it makes us nervous.

• Broadening narrative versus weak fundamentals: While investors leaned into a “broadening out” growth theme supported by falling unemployment, strong reported productivity, and a sharp trade deficit contraction, underlying data—especially weak manufacturing surveys, soft services indicators, and overstated GDP/productivity—suggest the expansion is not yet durable.

• K-shaped labor market and policy drag: Restrictive Fed policy combined with Trump-era demand shocks (trade, fiscal restraint, immigration) disproportionately weakened demand for less-skilled labor, with slowing job growth, cooling wages, low hours worked, and rising long-term unemployment reinforcing a “jobless expansion” despite a headline drop in unemployment.

• Inflation trending lower, Fed constrained: Despite weak labor and demand signals, data noise, seasonal adjustments, and divergence between BLS and Conference Board surveys have sidelined near-term rate cuts; nevertheless, we remain strongly convinced inflation will continue to decelerate through 1H26 and the FOMC will reduce the policy rate to our estimate of neutral, 3%.

• Trade deficit shock as a global risk: The dramatic collapse in the U.S. trade deficit appears driven by tariffs reducing goods imports rather than stronger growth, raising the risk of a secular deficit contraction that could trigger global deflationary pressures—particularly in China—and disrupt global capital flows.

• Policy-driven market implications: Government-backed MBS purchases, yield-curve steepening, and fading demand shocks support mortgages, curve steepeners, and dollar-devaluation beneficiaries, while recent equity broadening has boosted cyclicals and small/mid-caps—but may be running ahead of underlying economic reality.