United States

Can the US Labor Market Stay Strong?

The US labor market has stabilized, but the outlook remains uncertain. Nonfarm payroll growth has recovered from 2025 post-pandemic lows (Exhibit 4) and the unemployment rate has edged down to 4.3% in May from 4.4% in December. What is unclear is where the breakeven rate for nonfarm payroll growth relative to the unemployment rate will settle. The breakeven rate is the pace of employment growth necessary to keep pace with the growth of the labor force, such that the unemployment rate remains stable. It is a cornerstone metric that helps the Fed determine whether it is achieving its full employment mandate alongside price stability. In 2025, it appeared to have declined to ~50,000 jobs per month from the pre-pandemic level of ~140,000, largely reflecting reduced immigration, but the 2026 job growth figures and stable unemployment suggest a higher breakeven rate.

For the last two years, companies have slowed the pace of hiring without meaningfully cutting headcount. This is consistent with post-pandemic “labor hoarding,” as companies may now be rightsizing their workforces through attrition. At the same time, AI-driven automation expectations and tariff-related cost uncertainty are contributing to companies’ reluctance to hire. Adding to worker anxiety, Challenger, Gray & Christmas reported that from March to May 2026, the most important driver of job cuts was AI.

In an environment where AI appears poised to disrupt most of the service industry, workers are unlikely to demand large wage gains (despite the inflationary backdrop) or switch jobs. With real wages under pressure, consumers are unlikely to increase discretionary spending, which then feeds back to weaker labor demand.

The Fragility of a K-Shaped Economy

With sustained elevated inflation and a soft labor market, the K-shaped economy—in which higher income households thrive while lower income households struggle—is likely to worsen.

In general, the US population can be divided into two camps. The first is the ~42% of the US population that does not have any direct or indirect ownership of equities. Many of these people also do not own their homes, and their consumption is driven primarily, if not exclusively, by wage income. The second group is the portion of the population for whom accumulated wealth and the profits generated from that capital are relatively more important than labor market conditions and wages.

Of course, the reality is more complex: There are about 340 million individuals in the United States, each with their own circumstances, not just two simple groups. But overall, the divergent experiences of American households raise questions about the quality and sustainability of resilient macroeconomic performance. While US income inequality has long been a concern, Exhibit 5 illustrates the financial polarization facing US households. At the end of 2025, total US household net worth was $175 trillion. The bottom 50% of US households had total net worth of ~$4.3 trillion or 2.5% of the total, while the top 1% controlled $55.9 trillion, or 31.9%. The fact that ~1.4 million households have 13x the net worth of the bottom ~67.7 million highlights the extreme divergence in economic circumstances facing US consumers and their ability to withstand periods of high inflation and declining real wages.

Research from the Federal Reserve Bank of New York highlights the economic implications. High-net-worth households have driven a disproportionate share of retail spending in recent years,¹ while Americans on the lower part of the “K” continue to lose spending power. For this cohort, the accumulated shocks of the past several years have been severe: multi-decade-high inflation from 2021–2023 depleted pandemic savings; tariff-driven inflation arrived alongside a weakening job market in 2025; and the Iran War triggered another surge in energy and food prices in 2026. Add to these factors the fear of AI-driven job losses, and you have a recipe for consumer retrenchment.

With equities, housing, and other asset prices at or near all-time highs, I expect the United States to sustain solid real GDP growth—but I believe the quality of the growth will be suspect given the narrowing breadth of the drivers.

Midterm Elections and Economic Consequences

Since 1960, the party controlling the White House has lost an average of 26 House seats in midterm elections. Given the unpopularity of the Iran War and President Trump’s near-record-low favorability ratings, Democrats are optimistic about the November elections and the prospects for even bigger gains. However, Democrats face their own favorability challenges, and mid-cycle redistricting efforts could deliver a net Republican gain of as many as ten House seats. Democrats face more of an uphill climb in the US Senate, where they would need to gain four net seats to win control, as many of the seats currently held by Republicans are in solidly red states. Taking the factors into account, Lazard Geopolitical Advisory currently sees the Democrats as having an approximately 80% chance of winning control of the House versus an approximately 40% chance of winning a majority of the Senate (Exhibit 6), but these odds could change materially between now and November.

From a policy perspective, a Democratic House would likely prioritize restoring Medicaid funding and Affordable Care Act premium subsidies that were cut from the federal budget in 2025 and could threaten government shutdowns to obtain the funding. Meanwhile, both parties would likely support replenishing Pentagon munitions and increased national security spending. Tax increases would almost certainly be dead on arrival given Republican opposition, and I am skeptical that Congress will agree on offsetting spending cuts elsewhere. All of this could cause fiscal deficits to widen further.

Updating the most recent Congressional Budget Office deficit forecasts to reflect changes in tariff revenue assumptions and likely fiscal changes after the mid-term election, I expect US deficits to range from 6%–8% of GDP each year for the next decade. With rising deficits across developed markets, debt investors may demand a higher term premium for US Treasuries, leading to a steeper yield curve with higher long-term rates. We already began to see evidence of this dynamic in historically “risk-free” Treasuries in 2025, where significant fiscal expansion alongside dollar depreciation led to outflows from long-duration US Treasuries.

Federal Reserve Independence

With fiscal deficits widening further, Fed credibility will become even more important after the midterm elections in November. Unfortunately for new Fed Chair Kevin Warsh, investors will be looking for him to prove his independence where his predecessors were typically given the benefit of the doubt and assumed to operate independently of the White House. Against a backdrop of elevated inflation, a full-employment economy, and presidential admonitions for lower short-term interest rates, Warsh is in a tough spot.

Fortunately, the Federal Reserve Board and the Federal Open Market Committee (FOMC) are structured to avoid being excessively influenced by any single member. The 12 FOMC voters have equally weighted votes, and the majority rules. It is unclear what policies Warsh will advocate in his new seat, but he has argued in the past for a smaller Fed balance sheet and for rate cuts. Warsh also might seek to reduce the frequency of Fed press conferences or to eliminate some current communication tools such as the Summary of Economic Projections or the “dot plot” within it, which could add to market uncertainty around the direction of monetary policy.

Market anxiety regarding Fed independence has decreased recently as the case for policy easing has weakened, making the risk of unwarranted rate cuts less likely. The Fed Funds futures market has shifted from suggesting at least two rate cuts in 2026 as recently as February to now forecasting one or two 25-basis point (bps) rate hikes. But once the Iran War has conclusively ended, I expect markets to become more highly sensitized to any signs of Fed independence being weakened.