Why 2026 could be a turning point for the U.S. economy

Transcript:Caroline WoodsJoining me now, Brian Jacobsen, Chief economist, Annex Wealth Management. Brian, great to have you back. Thanks for joining us.Brian JacobsenYeah, thank you for having me.Caroline WoodsBrian, you say there's quite a bit to like about the outlook for 2026. Kick things off and tell us what you like.Brian JacobsenSure. Well, I think maybe part of it is that it's not 20, 25, that where it was a little bit of a low bar there in terms of the policy uncertainty that we knew that we were going to be facing in terms of, you know, tariffs, taxes, all sorts of other issues. But going into 2026, I think we're seeing some early signs that the labor market might be getting a little bit more traction.Brian JacobsenSo we are going through a period of time, a transition phase, negative payroll prints. But I think that we're actually beginning to turn the corner there because of the one big beautiful Bill act that was signed into law. We do know that consumers are likely going to be getting more generous tax refunds early in the year, so that could support some consumer spending.Brian JacobsenWe also know that there are tax incentives for spending by businesses on property, plant and equipment. So all that capital expenditures that should provide a little bit of a boost as well. And the fact that the fed seems to really have this almost like do no harm philosophy at the moment, they're probably not going to cut early in the year, but it seems like it would be a really high bar for them to have to hike.Brian JacobsenSo I just think that given some of that stimulus situation, the fed not necessarily being your enemy. I think that's really what sets us up for actually a maybe re acceleration of growth going into 2026.Caroline WoodsOkay. We'll get to the fed in just a second. But first I want to ask you about the Tuesday jobs report this week. Sort of unusual. We also have a CPI print later in the week. What picture will that data paint? Will it show this kind of turning the corner a point if you will.Brian JacobsenI think that the data we're going to get is from the October and November period, and where that could show that in October, basically it was still negative payroll growth, especially if you adjust for what economists have known as the overstatement of payroll growth. Back in August, the Bureau of Labor Statistics said that they had overestimated the level of payrolls all the way up until March.Brian JacobsenSo that's going to continue. So if you kind of handicap that by about the 60,000, it's probably going to be a negative number. November could be negative but not as negative. The real turning point that I'm really watching is with the ADP their weekly payroll number. Last week when it was after Thanksgiving, it showed that it finally turned slightly positive.Brian JacobsenAnd I think that we are showing some signs that that trend could continue. So the Tuesday number that we get it because it's for October and November, it's probably not going to reflect that turning point quite yet.Caroline WoodsSo a turning point for the the labor market, although we might not see it quite yet. What about in terms of inflation?Brian JacobsenIn terms of inflation? I think that we are seeing the volatility. If you think about where we were right after the tariffs were announced. There was an increase in goods prices. It shifted from a decline in goods prices year over year towards moving towards an increase in goods prices. But the service prices, especially when we're looking at shelter costs, new rents, we know that those are actually negative year over year.Brian JacobsenSo we could continue to see some of that sticky inflation with goods prices. But with the services inflation beginning to moderate and continuing that descent. And just given that the consumer basket is much more heavily biased towards services than goods, the overall pace of inflation, we think is going to really simmer down towards like maybe 2.5% by the end of 2026.Brian JacobsenSo coming down from 3% to 2.5%, it's going to be at like a glacial or at a snail's pace, but at least it's moving in the right direction.Caroline WoodsSo not quite at the Fed's target but getting closer to it. And with the labor market bouncing back in your view. And inflation coming closer to target, why would the fed need to cut rates anymore.Brian JacobsenThat's a great question. And I think that's what they're wondering too is are we at the sweet spot with rates. Given that we might see that improvement in the labor market decline and inflation? Have they done the proverbial sticking of the landing? Probably. They haven't actually stuck the landing quite yet. There might be some fine tuning adjustments that they need to make to the policy rate.Brian JacobsenMy base case is that we end 2026, and probably closer to about 3 to 3.25% with the fed funds target. And given that they currently have that 3.5 to 3.75% range, they're close to it. So I don't think they have to be in a hurry to cut. But it is nice to know that the majority of the fed is focused on the labor market weakness.Brian JacobsenSo that way they can almost like break the glass in case of emergency, where if we do see or don't see that turning point in the labor market that I'm expecting, then they could cut a little bit more aggressively.Caroline WoodsOkay. So your expectation is about two cuts in 2026.Brian JacobsenThat's correct. Yes. Probably about two cuts in 2026. Most likely June and December. I think they can be on hold until then.Caroline WoodsOkay. What about this K-shaped economy that we've been hearing a lot about?

Fed Chair Powell said. It's clearly a thing how real of a risk to growth is that?Brian JacobsenHonestly, I don't think it's a huge risk to growth, mostly because it's almost like the K is beginning to almost tilt a little bit more, where instead of the legs of the K, maybe it's upward sloping a little bit more. Because when we think about what the K-shaped recovery is really referring to is about high income earners doing better than lower income earners.Brian JacobsenBut that's always the case now is the wage growth. Income gains faster at the lower end or at the upper end. That's what really changed over the last say since it peaked out in terms of two years ago, where now higher income earners are getting faster wage gains than the lower income earners. But and I think this is critical, is that at the lower end, they're still getting real income growth.Brian JacobsenSo as long as their wage gains are beating inflation. No, it's not beating it by the same margin as higher income individuals. But it should still be supportive of consumer spending. So it's not an ideal situation. But it's not a dire one either okay.Caroline WoodsIn addition to the jobs data in the CPI print this week, we'll also get a read on retail sales and consumer sentiment. And then we get the the consumer health test this week in terms of earnings. General Mills, micron CarMax, Darden Restaurants Birkenstock Nike Fedex are really spanning the gamut in terms of groceries and footwear and shipping and tech.Caroline WoodsIf you had to give the consumer a letter grade for how they're faring right now, what would you give?Brian JacobsenI'm glad you asked, because actually, I also teach a class at Marquette University, and I'm just getting done doing all the grading. So I'm used to giving out grades here. Thankfully, all my students, they've been outstanding. But when it comes to the health of the consumer, I would say that when we're looking at that lower income consumer, it's probably about a C minus.Brian JacobsenIf we consider C being average with grade inflation, of course, maybe I should say that's like an A-minus, because it seems like the average seems to be closer to an eight, but they're not doing as well as what they historically should be on average. But it doesn't mean that they're failing when it comes to the higher income consumer.Brian JacobsenThat's where you've got a stock market that's up wage gains that are really accelerating. I think that's giving the higher and consumer consumer a grade of, at least in a if not an A-plus.Caroline WoodsAnd as you look to 2026, do you think those letter grades will get better? Can't get better than an A-plus, I guess for the higher income consumer. But do you think they'll get better or worse next year?Brian JacobsenYeah, I think we could give maybe an eight double plus, but I don't think it will get there. I think that it's actually going to get to closer to an A still get those wage gains. But for the most part, I don't think there's a lot of room for improvement or for higher income consumers to carry more of the load when it comes to spending.Brian JacobsenSo in terms of the lower income workers, I do think that that could go from like that C minus up towards a C, if not maybe a B minus, mostly because a lot of the wage gains and payroll gains. So the number of people being hired, I think we will see that acceleration. So this is a turning point for the labor market.Brian JacobsenI think where we're going to see that most evident is in that lower income group of the the household. So I'm expecting that 2026 is going to be a year in which maybe they can get a little bit of an upgrade.Caroline WoodsOkay. And just finally squeezing in one final question, do you have a top pick for Fed Chair? Who do you want to come out on top here?Brian JacobsenWell, I think when I look at the candidates, I don't see anything wrong with any of them. But my personal favorite would probably be Kevin Warsh, mostly because I think that with his academic background and he's been a little bit more distant from the white House, it would be a little bit easier for the markets to digest him being the chair.Brian JacobsenNow, of course, we do know that, President Trump is going to want to be consulted on monetary policy. There's a difference between being consulted and controlling. But from that perspective of the market, I think that it might have a little bit more credibility if the messaging is coming from a Kevin Warsh than, say, a Kevin Hassett.Caroline WoodsAll right. We'll leave it there.

Brian Jacobsen Chief Economist, Annex Wealth Management. Always a pleasure. Thanks so much.Brian JacobsenThank you.