Global Economic Outlook: Broadening US Growth, AI Productivity, and China's Deflation

The K-Shape Recovery's Hidden Costs and the Long Game for Global Growth

This conversation reveals the subtle yet critical ways economic expansions can become dangerously lopsided, primarily driven by a select group of consumers and a narrow sector of investment. The non-obvious implication is that relying on such a narrow base creates systemic fragility, masking underlying weaknesses that could derail broader growth. Investors and policymakers who grasp these dynamics gain a significant advantage by anticipating shifts in consumer behavior and identifying the true drivers of sustainable business investment, moving beyond the hype of AI to understand the cyclical forces at play. This analysis is crucial for anyone seeking to navigate the complex global economic landscape of 2026 and beyond, particularly those focused on the U.S., Euro Area, and Asian markets.

The Illusion of Broad-Based Strength: U.S. Consumer and CapEx Divergence

The narrative around the U.S. economy in 2025 was largely dominated by a tale of two segments: the resilient upper-income consumer and the AI-fueled business investment boom. While these factors provided aggregate strength, the underlying reality was a narrowly driven expansion with significant risks. Michael Gapen highlights that the upper-income consumer, buoyed by appreciating asset markets and home prices, continued spending even as inflation and tariffs disproportionately impacted lower- and middle-income households. This created a "K-shaped economy," where one segment thrived while others struggled. The implication here is that such a divergence is inherently unstable. As Gapen suggests, a broadening of this expansion in 2026 hinges on inflation coming down and the peak effects of tariffs subsiding, allowing lower- and middle-income households to contribute more significantly. This shift from a single engine to a dual-engine consumer is critical for sustained growth, moving beyond a temporary fix to a more robust economic foundation.

The business investment landscape mirrored this narrow focus. Gapen unequivocally states that AI CapEx spending was "the primary, almost exclusive story in 2025 for business spending." While this investment is substantial and important for the future, it masked weakness in other areas, like residential and non-residential spending unrelated to AI, which felt the sting of policy uncertainty. The sustainability of business spending, therefore, depends on two factors: the ongoing multi-year AI investment narrative and a broader cyclical recovery. For CapEx to truly broaden out, it needs to follow demand. A recovery in consumer spending, coupled with stabilizing labor markets and potentially lower mortgage rates, could create the necessary momentum for non-AI related business investment. This isn't just about growth; it's about building resilience. Relying solely on AI creates a vulnerability. If AI investment slows or faces unforeseen headwinds, the broader economy could falter. The "heavy lift" for a sustainable upswing involves this crucial broadening of demand and investment.

"So there is a K-shaped economy. I think one of the main risks about the US is that its expansion is narrowly driven. We think that will broaden out in 2026."

-- Michael Gapen

Euro Area's Uneven Acceleration and the German Fiscal Gamble

In the Euro Area, the economic picture is similarly complex, defying simple labels of "strong" or "weak." Jens Eisenschmidt describes it as "a little bit more complicated," characterized by uneven performance across member states. While Germany shows potential for acceleration, driven by fiscal stimulus, other economies like France and Italy are expected to remain below potential. Spain, though performing exceptionally, is too small to shift the regional aggregate. The projected outcome is a mild acceleration, with growth rates only moving above potential towards the end of the projection horizon in 2027. This paints a picture of a slow, deliberate recovery, not a sudden surge.

The excitement around German fiscal policy as a driver of European resilience is tempered by significant implementation lags and capacity constraints. While the fiscal space is substantial, the connection between abstract economic potential and market reality is often loose. Equity markets might desire immediate results, but the reality is a more drawn-out process. Eisenschmidt points out that defense procurement and other areas may lack the immediate capacity to absorb the stimulus. Furthermore, Germany's high trade exposure means that global trade friction could introduce short-term negative GDP surprises, complicating the narrative of immediate fiscal-driven growth. The medium-term outlook for Germany is positive, but the path is not immediate, and external factors like trade frictions pose a significant risk to the predicted trajectory. This highlights the danger of over-reliance on a single policy lever, especially when implementation is slow and external shocks are possible.

"So to my point before, it will take some time. We do have implementation lags... but the direction of travel is clear and up. So from that perspective, I have no doubts that the future is better for the German economy over the medium term... but it won't be immediate."

-- Jens Eisenschmidt

China's Deflationary Drag and the Limits of Currency Appreciation

China's economic narrative in 2026 remains challenging, primarily due to persistent deflationary pressures. Chetan Ahya anticipates that while deflationary pressures may ease, the economy will likely remain in deflation. This macro backdrop is contrasted by micro positives, particularly in advanced manufacturing. China is steadily increasing its market share in global goods exports, which is reflected in its outperforming export numbers. This micro story of gaining market share in exports is a key support for the corporate sector.

However, the role of the Renminbi (RMB) in reflating or rebalancing the economy is constrained by this deflationary environment. Ahya argues that the People's Bank of China (PBOC) is unlikely to allow significant currency appreciation because it would exacerbate deflationary pressures. Drawing a parallel to Japan's experience in the 1990s, the PBOC appears to be following a playbook that avoids currency appreciation when facing deflation. Furthermore, currency appreciation, in China's current context, could negatively impact corporate revenue, leading to wage cuts and a detrimental effect on consumption. Instead of aiding rebalancing towards consumption, appreciation could make it more difficult. The trade-weighted RMB has remained stable since 2016, and this stability is likely to continue, signaling a cautious approach from Beijing that prioritizes avoiding deflationary spirals over currency-driven rebalancing.

"We've learned from Japan's experience in the '90s that if you have deflation problem, you shouldn't be taking up currency appreciation, and we think PBOC pretty much follows that rule book."

-- Chetan Ahya

Actionable Takeaways

• Diversify Consumer Exposure (Immediate, Ongoing): Investors should analyze companies based on their exposure to different income segments, recognizing that upper-income consumers are currently the primary engine of U.S. growth, but this is not a sustainable long-term strategy.
• Look Beyond AI for CapEx Insights (Next 6-12 months): While AI investment is significant, a crucial indicator of broader economic health will be the pickup in non-AI related business spending, which tends to follow demand with a lag. Monitor consumer spending trends to anticipate this shift.
• Factor in Implementation Lags for Fiscal Stimulus (Ongoing): Understand that the impact of fiscal stimulus, particularly in Europe, will not be immediate. Focus on medium-term trends rather than short-term market reactions to policy announcements.
• Monitor Trade Friction for European Growth (Next 12-18 months): Germany's high trade exposure means that global trade dynamics, including potential tariffs and retaliations, will significantly impact its growth trajectory and, by extension, the broader Euro Area.
• Assess China's Deflationary Risks (Ongoing): Deflation remains a key challenge for China. Currency appreciation is unlikely to be a significant tool for rebalancing in the near term, as it could worsen deflationary pressures and hinder consumption.
• Anticipate Broader Asian Export Recovery (Next 6-12 months): Beyond tech exports, a turnaround in non-tech exports will be crucial for a broader recovery across Asian economies. Investors should monitor global demand for a wider range of goods.
• Consider AI's Productivity Boost (18-36 months): While rapid AI adoption could lead to faster real growth and disinflation, potentially allowing for policy rate cuts, the Fed's response will be data-dependent and may take time to fully materialize. This represents a delayed payoff for embracing technological advancement.