Viewpoint
April 24, 2026 | 15:11
Meet the Fog of War
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Meet the Fog of War |
| How the economy feels today depends more than ever on your vantage point. It’s a great time to be an investor or owner of capital, not so much if you are selling your labor. Equity and financial markets, in general, remain buoyant despite the headlines out of the Middle East or how much gasoline prices rise. Visions of record corporate profits are dancing in investors’ heads as AI euphoria dominates (Chart 1). Indeed, after-tax corporate profits as a share of GDP climbed to a record 11.5% in 2025Q4—and that’s before we really see a measurable lift in profits from productivity gains. |
| For some perspective: during the 1980s go-go economy and equity market, corporate profits only averaged 5.5% of GDP. Yep, you read that right: the S&P 500 index jumped around 250% with corporate profits running at less than half the current level. Even during the dotcom and PC internet bubble years, profits peaked at just 7.9% of GDP. ‘Buy the dip’ investors have been richly rewarded during this bull market, and stocks tend to rally when CEOs announce big layoffs or voluntary buyouts, like Meta, Nike, and Microsoft did this week, as companies reorganize for AI efforts. Global equities have healed rapidly, recovering all the losses recorded since the Iran war broke out (Chart 2). Fixed income investors concur. Despite credit market yips at the start of the conflict (that didn’t even reach last year’s tariff tantrum peaks), bond investors seem to have concluded the war is a non-event for U.S. credit risk. High-yield and investment grade Aaa corporate credit spreads have already dropped below pre-war levels (Chart 3). The view from the workforce, in contrast, is taking on more of a WWI trench warfare vibe. Many workers see a zero-sum game of career advancements and retreats as inflation eats into their nest eggs. Workers, in general, have seen a steady erosion of their share of the economic pie since the 1970s (Chart 4). Wages and salaries as a share of the U.S. economy peaked at 51.9% in 1970Q1, eroding to 42% by 2025Q4—near post-WWII lows. It’s this inequality that keeps me up at night. On the surface, the aggregate economic data still look fine, dare I say surprisingly resilient. S&P Global’s composite PMI for April jumped to a 3-month high, with the manufacturing gauge surging to a 47-month high of 54, though S&P Global noted the surge can be partly traced to “panic” and “emergency” buying ahead of anticipated price hikes and supply shortages. The March retail sales report was also stronger than expected with upward revisions in January and February. As a result, we nudged up our call for real consumer spending growth to 1.3% a.r. in Q1 (from 1.0% previously), raising our GDP growth estimate to a solid 2.3% (vs. 2.1%). But it will be robust business investment and government spending that lead the way. It is in this backdrop that the FOMC meets next week. Officials will be closely perusing the latest Beige Book report for clues on how prices and labor market conditions are adjusting to the Iran war. In contrast to the market’s exuberance, the April Beige Book was a mixed review. Eight of the twelve Federal Reserve districts reported only slight-to-modest growth with two little changed (St. Louis and San Francisco) and two others reporting slight-to-modest declines in activity (Boston and New York). The labor market looks stable with flat headcounts in most districts, but with price pressures intensifying in recent weeks. Given rising risks on both sides of the dual mandate, keeping rates on hold is the only sensible policy course until the fog of war clears. |
Fed Preview: The Waiting Game |
| The FOMC is expected to keep policy rates unchanged on April 29, with the target range for the fed funds rate at 3.50%-to-3.75%. This will mark the third straight pause after three consecutive quarter-point cuts during the final three confabs of 2025. A hold heralded the new year against the background of a stabilizing labour market and with policy rates “within a range of plausible estimates of neutral.” It initially afforded the Fed more time to better assess tariffs’ ultimate inflation impact. Then, the spike in oil prices that heralded March pumped the risks of both faster inflation and slower growth, making a more compelling case to play the ‘waiting game’. In the prior post-FOMC presser (March 18), Chair Powell was asked whether the Fed would look through the inflation tied to higher oil prices—despite missing the inflation target for the past five years. His response was profound, first referring to tariffs. “The thing that’s really important that we see this year is progress on inflation through a reduction in goods inflation, as the one-time effects [of tariffs]… go through the economy… The question of whether we look through the energy inflation doesn’t really arise until we have kind of checked that box.” Then, turning to oil prices, Powell said it is “kind of standard learning that you look through energy shocks, but that’s always been dependent on inflation expectations remaining well anchored, and I think now it’s also dependent now on what you mentioned [in your question], which is that broader context of five years now of inflation above target.” So, the Fed will be interpreting any increase in total inflation due to higher oil prices in the context of not having hit the 2% target for the past five years and still waiting for progress on the core goods inflation front. The CPI increased 0.9% in March, lifting total inflation from 2.4% y/y in February to 3.3% y/y, with gasoline prices jumping more than 21% in the month alone. Core inflation inched up a tenth to 2.6% y/y and core goods inflation moved up two tenths to 1.2% y/y. The latter was running in negative territory before new tariffs arrived, and before pandemic-related pressures propelled it to a 47-year high (12.3% y/y), which means requisite ‘progress’ is still pending. Meanwhile, the labour market continued to stabilize in March, affording more policy pause time. The growth in payrolls averaged a ‘sideways’ 68k in the latest three months (the spot figure was a 15-month high 178k) with the unemployment rate at 4.3% (oscillating between 4.3% and 4.4% for the past four months). So, the waiting game can continue, which is the last round scheduled to be played by Powell as Fed Chair with the term ending May 15. Kevin Warsh had his nomination hearing this week, to follow Powell as Fed Chair. The Justice Department announced on April 24 that it had dropped its investigation of Powell over his Congressional testimony on the cost of renovations to the Fed’s HQ. This was the pre-condition Republican Senator Tillis had set to vote in favour of the nomination. If confirmed, Warsh will be assuming the ‘big chair’ when the FOMC next gathers on June 16-17. It’s still unclear whether Powell will stay on the Fed Board of Governors for a while longer (that term ends in 2028), until the Supreme Court rules on the President’s ability to fire Governor Lisa Cook. Stay tuned. |
Regional Economy: AI on the PrizeSome Northeast states topped the growth table on tech exposure. |
| The economy grew 2% y/y in 2025Q4, but many states outperformed the national average (Chart 1) largely because they entered the period with greater exposure to faster-growing service industries and smaller exposure to slower-growing, or contracting, sectors. As shown in Table 1, four industries collectively drove more than three-quarters of total GDP growth, even though together they represented less than 30% of the economy. They are: (1) information; (2) health care and social services; (3) finance and insurance; and (4) professional, scientific, and technical (PS&T) services. Growth in information and PS&T services has been well supported by the AI boom. Meantime, health care has been shored up by an aging population with vigor reflected in its job creation. And finance was driven by record equity markets, which are also tied to AI‑related gains. Table 2 highlights how this played out at the regional level. Among the 50 states, Massachusetts led Q4 growth at 3.3% y/y, with New York, Connecticut, and New Hampshire also ranking in the top six—an unusually strong showing for the Northeast. These states shared above‑average exposure to the fastest‑growing service industries, and their outperformance reflected broad strength across multiple sectors, rather than a sole reliance on any single one. Below, we examine the key industries in more detail and the states that benefited the most from them. |
| 1. InformationThe information sector held the pole position for real GDP growth by industry, contributing the most to total growth despite representing just over 5% of the economy. The sector includes businesses in the high-tech arena, generally, and those involved with AI and automation, specifically, such as software (and other) publishing along with information and data processing. These two areas account for around 60% of the sector’s output, which also includes motion pictures and sound recording along with broadcasting and telecommunications. States with elevated exposure to information—most notably Connecticut, California, New York, Massachusetts, and Colorado—benefited directly, reinforcing their presence in the first or second growth quintiles. 2. Health Care and Social AssistanceHealth care and social assistance—accounting for roughly 8% of total GDP—emerged as one of the most important contributors to national growth due, in part, to powerful demographic underpinnings. Massachusetts, South Dakota, Connecticut, New Hampshire, Pennsylvania, and Tennessee benefited from this as these states had a greater exposure to the health industry. Meantime, states with older populations, slower labor force growth, or higher concentrations of retirees tended to have structurally higher demand for medical services, long‑term care, and social assistance. In these regions, the sector did not necessarily propel growth into the top tier, but it anchored GDP performance and limited downside risk. 3. Finance and InsuranceFinance and insurance also played a meaningful role in lifting national GDP, amid equity markets rallying to record highs. Among the 10 fastest-growing states, many had larger than average financial sectors including: Massachusetts, New York, South Dakota, Connecticut, Utah and North Carolina. |
4. Professional, Scientific, and Technical ServicesProfessional, scientific, and technical services ranked among the top contributors to U.S. GDP growth, reflecting continued demand for high‑skill labor, consulting, engineering, and R&D‑intensive activities. The sector’s importance lies in its role as an amplifier of innovation, technology adoption, and productivity gains. States with higher-than-average concentrations of PS&T services—Massachusetts, New York, New Hampshire, Florida, California, Pennsylvania, Illinois, and Colorado—exceeded national growth. In some of these states, PS&T services both complemented and extended the reach of the information sector. |
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| Other notable sectors: Durable goods manufacturing Tariffs on imported inputs have been problematic for durable goods manufacturers, despite the extra protection provided by tariffs on foreign finished products. However, sturdy domestic demand, particularly for capital goods, has kept factory activity humming with yearly growth topping 4.0% y/y. Among the 10 strongest-growing states, Connecticut and Indiana have particularly large exposures to durable goods manufacturing. The former has a focus on aerospace and defence, benefitting from increased military outlays. The latter has the largest exposure of any state, paced by transportation equipment and industrial machinery. |
Real Estate, Rental, and Leasing The real estate, rental, and leasing sector remains the largest single industry by GDP share, accounting for nearly 14% of national output, and thus providing a substantial contribution to overall growth, despite growing ‘only’ 2.3% y/y amid muted housing market activity. This sector tends be more influenced by population growth, meaning Texas and the Southeast states are among the areas receiving the most support (Chart 2). |
Federal government Owing to the record-long federal government shutdown in Q4, the sector’s real output dropped 9.3% y/y. With the shutdown ending, activity will rebound in Q1. And the growth see-saw will also occur in the states most exposed to federal government activity and employment; D.C.-bordering Virginia and Maryland. Both registered Bottom-10 yearly growth rates with Maryland being the only state to contract. (For the record, the District of Columbia’s economy contracted 2.4% y/y in Q4.) Big Picture: States that combined above‑average weights in information, health care and social assistance, finance and insurance, and PS&T services formed clear clusters of outperformance (i.e. the Northeast). Where these exposures were absent, states generally lagged, even amid a still-healthy expansion at the national level. |