Morgan Stanley believes the U.S. economy will be supported by AI capital expenditure, while consumption is weighed down by higher oil prices.

Overview

The core view in this Morgan Stanley U.S. midyear outlook is that "capital expenditure outweighs consumption." Under the base case that Middle East tensions gradually ease, the report argues that higher oil prices will create short-term inflation and pressure on consumer purchasing power, but will not trigger a broad U.S. economic downturn. AI-related capital expenditure is more structural than cyclical, and will continue to support nonresidential investment, productivity, and overall growth in 2026-2027.

Core views

The report expects real U.S. GDP to grow 2.3% in 2026 and 2.6% in 2027. On the consumption side, higher gasoline prices are expected to offset the tax refunds and income support from OBBBA, slowing real consumption growth to 1.8% in 2026. Low- and middle-income households face greater pressure, while high-income households are supported by wealth effects. On the investment side, AI-related spending remains strong, with nonresidential fixed investment expected to grow 7.0% in 2026 and 8.0% in 2027. On the policy side, the fiscal deficit remains around 6% of GDP, the tariff regime becomes more durable, and the Fed stays on hold in 2026 due to supply shocks and inflation pressure, before cutting modestly once inflation eases in 2027.

Analysis framework

The report combines macro forecasting, policy scenario analysis, income-tiered consumption analysis, oil-price transmission mechanisms, AI capital expenditure decomposition, productivity contribution analysis, and a Federal Reserve policy-path simulation. The base case centers on gradual de-escalation in the Middle East, a mild oil risk premium, limited fiscal stimulus, continued AI investment, and a gradual decline in inflation, while four alternative scenarios are used to assess upside and downside risks.

Methodology notes

• Macro scenario analysisBase case and alternative scenarios

  Build the base case and four alternative scenarios using Middle East conflict, oil prices, consumer confidence, AI productivity, and global recession risk as key variables.

  The base case assumes tensions gradually ease, growth stays near trend, and inflation rises in the near term before easing; alternative scenarios include stronger aggregate demand, AI-driven productivity gains with labor substitution, a persistent oil risk premium, and a global recession.

• Consumption analysisIncome stratification and energy price transmission

  Analyze the impact of gasoline prices, tax refunds, real income, and wealth effects on consumption by income group.

  Low- and middle-income groups spend a higher share on energy and are more easily squeezed by rising gasoline prices; high-income groups hold most of the net wealth and stock assets, so their consumption is more resilient.

• Investment analysisAI-related vs. non-AI capital expenditure decomposition

  Break nonresidential fixed investment into AI-related and non-AI components to assess their contributions to GDP and productivity.

  AI-related investment becomes the dominant driver of nonresidential investment in 2025-2026, while non-AI investment remains weak but shows signs of stabilization; the investment cycle may broaden in 2027.

• Monetary policy analysisFederal Reserve reaction function under inflation constraints

  Derive the rate path based on core PCE, supply shocks, labor market conditions, and changes in the neutral rate.

  The report argues that inflation and oil shocks in 2026 raise the hurdle for cuts, keeping the Fed on hold; if inflation eases in 2027, the Fed could cut modestly.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• U.S. macroeconomy

  Primary research subject

  Strengths

  Growth near trend, stable labor market, and AI capital expenditure providing resilience.

  Weaknesses

  Weak real consumption income, higher energy prices, and a large fiscal deficit.

  Comparison

  Compared with the more optimistic consumption assumptions at the start of the year, the report lowers consumption momentum but raises or maintains support from AI investment.

  Risks

  Further oil price increases, sticky inflation, policy uncertainty, and a global recession.

• U.S. consumption

  Mainly pressured variable

  Strengths

  High-income households have strong wealth levels, and services consumption is relatively stable.

  Weaknesses

  Gasoline prices offset refund support, and the real purchasing power of low- and middle-income households is under pressure.

  Comparison

  Consumption growth in 2026 is below the 2012-2019 average, with only a mild recovery expected in 2027.

  Risks

  Labor market deterioration, tighter credit, asset market declines, or persistently high energy prices.

• AI-related capital expenditure

  Core support variable

  Strengths

  Spending is more structural, hyperscaler investment continues to be revised up, and the contribution to nonresidential investment and productivity is significant.

  Weaknesses

  Imports offset part of the GDP accounting contribution, and non-AI investment remains weak.

  Comparison

  AI-related investment is clearly stronger than non-AI investment in 2025-2026.

  Risks

  Energy constraints, weaker-than-expected returns on capital spending, and more visible labor substitution from AI adoption.

• Federal Reserve policy rate

  Policy transmission variable

  Strengths

  The labor market remains balanced, leaving room for cuts once inflation falls in 2027.

  Weaknesses

  Supply shocks and inflation pressure in 2026 raise the hurdle for cuts.

  Comparison

  Relative to a faster easing path, the report emphasizes patience and data dependence.

  Risks

  Core inflation staying above expectations, an upward move in r*, or communication uncertainty from a new Fed chair.

• Energy and oil prices

  Key exogenous shock

  Strengths

  The base case assumes tensions gradually ease, and the U.S. is less exposed than Asia and Europe.

  Weaknesses

  Gasoline prices directly reduce real purchasing power and may spill over through inflation expectations and business confidence.

  Comparison

  The oil shock is similar to several recent supply shocks, but currently shows up mainly as consumer purchasing-power pressure rather than a broad growth shock.

  Risks

  Oil rising to $140/bbl or staying near $120/bbl would materially raise recession and inflation risks.

Key data

• U.S. real GDP growth2.3% in 2026; 2.6% in 2027Base case, assuming Middle East tensions gradually ease and AI capital expenditure offsets the drag from consumption.
• Real consumption growth1.8% in 2026; 2.1% in 2027Weighed down in 2026 by gasoline prices and pressure on real income, then recovers in 2027 as inflation eases and income improves.
• Nonresidential fixed investment growth7.0% in 2026; 8.0% in 2027Driven mainly by AI-related capital expenditure and hyperscaler spending.
• Hyperscaler capital expenditureAbove $1 trillion in 2027The report sees this as important evidence that AI investment remains strong.
• Core PCE inflation2.8% in 4Q/4Q 2026; 2.3% in 2027Inflation is expected to ease gradually, but the risk is skewed toward greater persistence.
• Federal Reserve policy pathUnchanged in 2026; 25 bp cuts in March and June 2027The expected terminal target range is 3.0%-3.25%.
• Fiscal deficitAbout 6% of GDPThe report expects the fiscal deficit to remain elevated, with low odds of large pre-election fiscal stimulus.
• Tax refunds and gasoline pricesRefunds up about 17% y/y, with average refunds up about $323; a 15% rise in gasoline prices adds about $375 to annual gasoline spendingIf gasoline prices stay high, energy spending will offset the support from refunds to consumption.
• Labor marketMonthly job gains of about 50k to 60k; unemployment rate falls to 4.1% in 2027The upward pressure on unemployment from AI adoption is currently seen as limited.
• Impact of AI on unemploymentAt most a 0.1 percentage point increaseThe report argues that AI currently shows up more as higher output and task reallocation than as macro-level labor substitution.

Impact & implications

In terms of assets and macro implications, the report supports the view that U.S. growth is not weak but structurally bifurcated: consumption is not the main growth engine, while AI capital expenditure, productivity gains, and wealth effects among higher-income households are the more important supports. On rates, elevated near-term inflation makes it difficult for the Fed to cut quickly in 2026, and duration assets remain sensitive to sticky inflation and oil-price risk. At the sector level, the macro backdrop is more supportive for AI infrastructure, compute, power, and related equipment chains than for traditional consumer goods; consumption-linked categories serving low- and middle-income households face greater pressure.

Risks

• Oil prices rise significantly above the base case or stay elevated for longer, leading to nonlinear deterioration in consumption, inflation, and business confidence.
• Core PCE inflation proves stickier, preventing the Fed from cutting as expected in 2027.
• If AI adoption leads to more visible labor substitution, unemployment could rise and weigh on labor income and consumption.
• A sharp decline in asset markets would erode wealth effects among high-income households and could turn consumption negative.
• Tariff policy, the USMCA review, IEEPA tariff refunds, and fiscal negotiations could renew policy uncertainty.
• If the Middle East conflict escalates and triggers a global recession, the report's trend-growth base case would no longer hold.

What to watch

• Whether Brent crude and U.S. retail gasoline prices fall back into the base-case range.
• Whether core PCE inflation, housing inflation, and tariff pass-through continue to cool.
• Real disposable income, real labor income, and consumption data for low- and middle-income households.
• Hyperscaler capital spending guidance, AI infrastructure buildout, and execution of power and compute investment.
• Whether non-AI investment stabilizes out of the slump and broadens in 2027.
• Monthly job gains, unemployment, and hiring and layoff data in AI-exposed industries.
• The Fed's 2026 communication, the new chair's priorities, and balance-sheet policy discussions.
• Fiscal plans around the midterm election, execution of SNAP and Medicaid cuts, government shutdown risk, and changes in defense spending.