AI-Driven Demand Disconnect Complicates Federal Reserve Policy

Bloomberg Surveillance · December 23, 2025 · Listen to Original Episode →

Original Title:

TL;DR

The US GDP print of 4.3% for Q3, while strong, exacerbates the disconnect between robust aggregate demand and sluggish employment growth, potentially causing Fed officials to question past rate cuts.
AI and robotics are decoupling strong final demand from weak hiring, meaning traditional rate cuts may be insufficient to stimulate job growth if AI adoption continues to displace workers.
Tariffs are expected to pass through to consumer prices, making the Federal Reserve's insurance rate cuts expensive and further delaying the achievement of its 2% inflation goal in 2026.
The Federal Reserve faces a dual mandate tension, with potential employment deviations weighing more heavily than current inflation deviations, influencing its rate decisions despite the 2% target.
The market anticipates a cyclical rotation in equities in 2026, driven by broader earnings growth beyond tech, potentially leading to valuation expansion in non-tech sectors.
Global yields, particularly from Japan, could exert upward pressure on US Treasury yields, complicating the Federal Reserve's monetary policy decisions and potentially leading to higher-for-longer rates.
The consumer economy is bifurcated, with middle and upper-income consumers benefiting from wealth effects, while lower and middle-income consumers may struggle, impacting overall economic growth dynamics.

Deep Dive

The US economy is exhibiting a significant disconnect between robust aggregate demand, fueled by AI spending and high-income consumers, and sluggish employment growth, a trend that complicates the Federal Reserve's monetary policy decisions. This divergence suggests that traditional rate-cutting measures may have limited impact on addressing AI-driven job displacement, potentially prolonging the path to the Fed's 2% inflation target and necessitating a recalibration of policy expectations for the coming year.

The strong GDP print for the third quarter, rising 4.3%, has exacerbated existing divisions within the Federal Reserve, with nearly half of FOMC participants questioning the necessity of recent rate cuts given the resilience of aggregate demand. This data, though stale, highlights the challenge the Fed faces in balancing its dual mandate of maximum employment and stable prices. While inflation is closer to its 2% goal than before, the sluggishness in hiring, potentially driven by AI and automation, weighs more heavily on the employment mandate. Consequently, the Fed's insurance cuts may prove costly, delaying the achievement of its inflation target as it navigates labor supply headwinds and demand tailwinds that are largely unresponsive to overnight interest rates. Furthermore, fiscal policies such as tax refunds and agricultural subsidies, coupled with potential tariff dividends, could exert upward pressure on inflation, further complicating the Fed's task and potentially delaying rate cuts into 2026.

The implications for financial markets are substantial. The disconnect between strong growth and muted hiring, alongside potential inflationary pressures from fiscal policy, suggests that the Federal Reserve may cut rates less than anticipated, leading to a "higher for longer" interest rate environment, particularly at the long end of the yield curve. This scenario supports a constructive outlook for 2026, with constructive outlooks for equities driven by broadening earnings growth, AI diffusion, deregulation, and fiscal stimulus. However, the market faces a "K-shaped" economy, where certain sectors, particularly technology and high-income consumer services, thrive, while labor market gains stagnate. This dynamic necessitates a focus on earnings growth and potential valuation expansion in cyclical and value stocks, as the market grapples with the evolving economic paradigm. The ongoing bidding war for Warner Bros. Discovery, with Paramount's increased offer backed by Larry Ellison, underscores the strategic importance of media assets, signaling a potential consolidation that could lead to a more competitive streaming landscape, though regulatory scrutiny and differing cost-reduction plans present significant hurdles.

Action Items

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Key Quotes

"part of what it does is make you wonder why the federal reserve felt the need to buy three quarters percentage worth of insurance by cutting rates since september but that was more about employment what it does is exacerbate the disconnect we're having between our view of aggregate demand growing at such a rapid rate and employment which is pretty sluggish"

Vincent Reinhart, Chief Economist at BNY, highlights a disconnect between strong aggregate demand and sluggish employment growth. Reinhart questions the Federal Reserve's rate cuts, suggesting they may have been unnecessary given the economic data at the time. This observation points to a potential miscalibration of monetary policy in response to evolving economic conditions.

"well they'd never admit that you you don't give up on your goal when you're far away from it that's so that's why chair powell vigorously defends 2 and denies any idea that they've changed their goal i think 2 is a long run aspiration and what we've seen over the last three months in particular is that they're willing to put off that achievement to buy a little more insurance"

Vincent Reinhart explains that Federal Reserve officials, including Chair Powell, publicly maintain the 2% inflation target despite current deviations. Reinhart suggests that the Fed is willing to delay achieving this goal to implement precautionary measures, indicating a strategic approach to managing economic uncertainty. This implies a pragmatic rather than rigid adherence to stated targets when faced with complex economic environments.

"i do believe that tariffs ultimately pass through to consumer prices and two things have happened one is we haven't seen all the pass through of the increase in tariffs we've already gotten and that over the course of the year the effective tariff rate kept rising so you're exactly right there's more tariff feed through to consumer prices that's why in our own forecast we think that the insurance the federal reserve bought by cutting rates will be expensive next year it's going to even further delay getting to a 2 goal"

Vincent Reinhart argues that tariffs directly increase consumer prices, with the full impact yet to be realized due to ongoing tariff rate increases. Reinhart connects this to the Federal Reserve's policy, predicting that the "insurance" provided by rate cuts will become more costly as it further delays reaching the 2% inflation target. This suggests a complex interplay between fiscal policy (tariffs) and monetary policy (rate cuts) affecting inflation.

"dan skelly of morgan stanley wealth management says the outlook into 2026 remains constructive supported by increased m a broadening out of earnings growth ai diffusion deregulation and fiscal stimulus"

Dan Skelly of Morgan Stanley Wealth Management presents a constructive economic outlook for 2026. Skelly attributes this optimism to several key factors: increased mergers and acquisitions activity, wider distribution of earnings growth, the spread of artificial intelligence, deregulation, and fiscal stimulus. This indicates a multi-faceted economic recovery driven by both technological advancements and policy initiatives.

"i think on the equity front just coming back to stocks i think it's going to be a continuation of this cyclical rotation that we've seen really in the past one to two months we do have increasingly bullish expectations for earnings in 2026 i mean it's not like the fed is the only thing that drives markets right obviously the real economy is important and i'm hearing from economists i've been talking to joe brusuelas here in my ib chat that he still sees strong growth strong final demand listen if we're running at a 7 nominal gdp we would hope that the average company is going to see revenues increase right because there's some correlation there but i think the big catalyst for next year matt is all about ai monetization we've been waiting for good dough in terms of when does ai spread out from the mag 7 to the rest of the fortune 100 and frankly i think that's where we could see upside surprise next year"

Dan Skelly anticipates a continuation of cyclical rotation in the stock market, driven by increasingly bullish earnings expectations for 2026. Skelly emphasizes that market performance is influenced by the real economy, not just the Federal Reserve, and highlights AI monetization as a significant catalyst for the upcoming year. Skelly expects AI's impact to expand beyond major tech companies to the broader Fortune 100, potentially leading to upside surprises.

"mona mahajan of edward jones with a constructive outlook for next year writing elevated tech valuations improving liquidity and better earnings momentum across cyclicals mid caps and international equities support a potential rotation"

Mona Mahajan of Edward Jones expresses a constructive outlook for the upcoming year, supported by several factors. Mahajan points to elevated tech valuations, improving market liquidity, and enhanced earnings momentum across cyclical stocks, mid-cap companies, and international equities as drivers for a potential market rotation. This suggests a belief in a broadening market rally beyond current leaders.

"peter supino of wolfe research joins us now for more peter i don't know where to start i cannot wait to watch the movie of how this saga absolutely unfolded who do you think is actually going to win out in the end first i want to praise you on that transition from obesity drugs to studios beefing up on buying each other we think paramount has a slight edge in what is a really tight horse race these horses are neck and neck the bids are tricky to compare they're just a dollar apart if you adjust for the various ways you should adjust them"

Peter Supino of Wolfe Research discusses the competitive bids for Warner Bros. Discovery, noting that Paramount has a slight edge in what he describes as a tight race. Supino highlights the difficulty in comparing the bids directly, stating they are very close in value when adjusted appropriately. This indicates a complex negotiation process where subtle differences in the offers are critical.

Resources

External Resources

Books

"The One Big Beautiful Bill" - Mentioned in relation to potential fiscal stimulus through tax refunds.

Articles & Papers

"Bloomberg Surveillance TV: December 23rd, 2025" (Bloomberg) - Episode title providing context for the discussion.

People

Vincent Reinhart - Chief Economist at BNY, discussed regarding US GDP print and Federal Reserve policy.
Dan Skelly - Managing Director at Morgan Stanley Wealth Management, shared outlook for 2026.
Mona Mahajan - Head of Investment Strategy at Edward Jones, discussed bullish outlook for equities.
Peter Supino - Senior Analyst at Wolfe Research, provided insights on Paramount Skydance's bid for Warner Bros. Discovery.
Joe Brusuelas - Economist at RSM, discussed decoupling between strong growth and weak hiring due to AI.
Beth Hammack - Mentioned as a voting member concerned about inflation and advocating for maintaining policy.
Art Lafferty - Mentioned as having appeared on Fox and suggesting a 5% GDP growth rate.
Brian Roberts - Mentioned as having significant voting power at Comcast and preferring a conglomerate structure.
Corbin Wittington - Mentioned as an individual who found strength through community after being diagnosed with CIDP and dilated cardiomyopathy.
Larry Ellison - Mentioned for providing a $40 billion personal guaranteed backstop for Paramount's bid.
David Ellison - Mentioned as wanting to make and show movies in theaters, aligning with the creative community's preference.
Matt - Co-host of the podcast, engaged in discussions about economic data and market trends.
Lisa Abramowicz - Co-host of the podcast.
Amaryllis Herndon - Co-host of the podcast.
Jonathan Ferro - Host of the podcast.
Martine Hackett - Host of "Untold Stories: Life with a Severe Autoimmune Condition."

Organizations & Institutions

BNY - Employer of Vincent Reinhart.
Morgan Stanley Wealth Management - Employer of Dan Skelly.
Edward Jones - Employer of Mona Mahajan.
Wolfe Research - Employer of Peter Supino.
RSM - Employer of Joe Brusuelas.
Federal Reserve - Discussed in relation to interest rate policy and inflation targets.
FOMC (Federal Open Market Committee) - Mentioned in relation to the division among participants on rate cuts.
JP Morgan Asset Management - Brand name for the asset management business of JP Morgan Chase & Co.
JP Morgan Distribution Services Inc. - Entity issuing communications for JP Morgan Asset Management.
Finra - Member of which JP Morgan Distribution Services Inc. is a part.
Optum - Company using technology to simplify healthcare.
Bloomberg Audio Studios - Producer of podcasts and radio news.
Bloomberg Television - Platform where the show is broadcast live.
Bloomberg Terminal - Platform where the show is available.
Bloomberg Business App - Platform where the show is available.
New England Patriots - Mentioned as an example team for performance analysis.
Pro Football Focus (PFF) - Data source for player grading.
NFL (National Football League) - Primary subject of sports discussion.
Paramount Skydance - Mentioned in relation to its bid for Warner Bros. Discovery.
Warner Bros. Discovery - Company involved in a bidding situation with Paramount Skydance and Netflix.
Netflix - Competitor in the bidding for Warner Bros. Discovery.
Comcast - Parent company of NBC Universal.
NBC Universal - Media business with film, television, and theme park production.
CVS - Company serving communities and providing prescriptions and snacks.
Argentix - Partner in the production of "Untold Stories: Life with a Severe Autoimmune Condition."
Ruby Studio - Producer of "Untold Stories: Life with a Severe Autoimmune Condition."
Disney - Competitor in the streaming service market.
Apple - Technology company with streaming services.
Amazon - Technology company with streaming services.
YouTube - Platform with streaming services.

Tools & Software

Odoo - All-in-one integrated business software platform.
Cisco Duo - Security solution providing multi-factor authentication and phishing resistance.

Websites & Online Resources

omnystudio.com/listener - Provided for privacy information.
discovercart.com - Website to learn more about CAR T-cell therapy.
optum.com - Website to learn more about Optum.
jpmorgan.com/getactive - Website to learn more about JP Morgan Asset Management's active fixed income ETFs.
odu.com - Website to try Odoo for free.
duo.com - Website to learn more about Cisco Duo.
spectrum.com/freeforever - Website to learn more about Spectrum's free home internet offer.

Podcasts & Audio

Bloomberg Surveillance Podcast - Podcast featuring discussions on markets, economics, and geopolitics.
Untold Stories: Life with a Severe Autoimmune Condition - Podcast sharing stories of resilience from people living with MG and CIDP.

Other Resources

CAR T-cell therapy - Personalized treatment for multiple myeloma.
Prime Video - Streaming service offering movies and shows.
AI (Artificial Intelligence) - Discussed as a factor in job displacement and economic growth.
Robotics - Mentioned as a potential factor in job replacement.
2% Inflation Target - Federal Reserve's goal for inflation.
Dual Mandate - Federal Reserve's responsibility for maximum employment and stable prices.
K-shaped economy - Economic model describing divergence in outcomes.
Mag 7 - Group of seven large technology companies.
Peloton - Metaphor for differentiation within the Mag 7.
Money Center Banks - Mentioned as leading sectors.
Healthcare - Mentioned as a leading sector.
Tax Refunds - Potential fiscal stimulus discussed.
Tariffs - Discussed as a factor influencing prices and inflation.
Warrior Dividend / Tariff Dividend - Potential policy from President Trump.
Fiscal Stimulus - Government spending to boost the economy.
Midterms - Upcoming elections influencing policy timing.
Affordability - Consumer concern influencing policy.
Goods Inflation - Component of inflation related to physical products.
Services Inflation - Component of inflation related to services.
Shelter and Rent - Major components of services inflation.
Wealth Effects - Impact of asset price increases on consumer spending.
Repatha (evolocumab) - Medication mentioned for lowering LDL cholesterol and reducing heart attack risk.
Statin - Type of medication often used with Repatha.
LDL C (Low-Density Lipoprotein Cholesterol) - "Bad cholesterol."