The U.S. economy is fracturing along a "K-shaped" trajectory: high-income groups are enjoying asset appreciation and a consumption boom, while low-income groups are mired in rising rents, debt pressures, and a weak job market. This structural divergence is pushing the Federal Reserve into a difficult dilemma that traditional monetary policy tools struggle to resolve.
A recent research report from Bank of America Securities on June 29 indicates that this K-shaped consumption pattern began to emerge from late 2024 into early 2025 and has intensified further into 2026 due to energy price increases triggered by the Iranian conflict. High-income households receive additional support from tax cuts, while rising energy prices act like a regressive tax, hitting low-income families harder. This K-shaped economy makes aggregate demand appear stronger on the surface than it truly is, while significantly increasing the risk of policy miscalculation.
Economists Shruti Mishra and Aditya Bhave from Bank of America Securities state in the report that the Fed's monetary policy is both a partial cause of the K-shaped divergence and powerless to directly fix it. Faced with a scenario where "re-inflation" for high-income groups coexists with "mild stagflation" for low-income groups, gradualism is currently the most prudent policy approach, aligning with the Fed's recent practical path.
Quantifying the K-Shaped Split: Concentration of Consumption at the Top
The starting point for understanding the Fed's predicament lies in recognizing the high concentration of U.S. consumption structure.
According to U.S. Bureau of Labor Statistics consumer expenditure survey data, the top 10% of households by income account for approximately 23% of total national consumption, while the bottom 10% contribute only about 4%. This stark disparity means that overall consumption trends are largely dictated by the balance sheets, wealth effects, and spending behaviors of high-income groups.
Differences in consumption baskets are also severely divided. Low-income families (bottom 10%) allocate 63% of their spending to necessities like energy, groceries, housing, and healthcare. In contrast, high-income families (top 10%) spend only 31% on such essentials, with 43.5% directed towards discretionary services. This structural difference determines that when energy prices or rents rise, the impact lands with vastly different intensity on the two groups.
Bank card data shows that non-discretionary spending (i.e., gas, groceries, and utilities) for low-income households is under greater pressure, further squeezing their discretionary consumption space and perpetuating the K-shaped divergence in this dimension.
How the K-Shaped Economy Explains the "Strong Consumption, Weak Jobs" Paradox
Over the past year, markets have been perplexed by a data paradox: a persistently cooling labor market alongside resilient consumer spending. The K-shaped consumption structure is key to solving this puzzle.
Since aggregate consumption is led by high-income households—a group benefiting from stock wealth effects, stable housing costs (many locked in low-rate fixed mortgages pre-pandemic), and more favorable fiscal dynamics—their spending has remained robust even as the job market weakens. Meanwhile, the cooling in employment data is partly due to a labor supply shock from tightened immigration restrictions. As the immigrant population accounts for a relatively limited share of total consumption, this further amplifies the divergence between employment and consumption signals.
Given that over five-sixths of private-sector jobs are in services, as long as service consumption remains robust at the aggregate level, labor demand is unlikely to deteriorate sharply. Recent non-farm payroll data has comfortably exceeded break-even levels, and job growth has spread beyond education and healthcare into broader sectors, aligning with the firm's "optimistic baseline scenario."
The Fed's Policy Conundrum: Both Cause and Lacking a Cure
The report directly highlights the Fed's awkward position: monetary tightening has, to some extent, reinforced the K-shaped divergence, yet monetary policy itself cannot directly fix the problem.
Since March 2022, the Fed has cumulatively raised rates by 350 basis points. Even after rate cuts in 2024 and 2025, the current policy rate remains relatively high at 3.50%-3.75%. Tightening has exacerbated the divide between income groups through two channels.
First, the credit cost channel. Credit card rates have surged alongside the federal funds rate. Research from the Boston Fed shows that a 1 percentage point increase in credit card APRs leads to an approximate 9% drop in overall card spending the following month, with the impact on low-income consumers with balances and lower credit scores being about twice that on high-score consumers.
Second, the housing cost channel. Rent inflation rose significantly during the tightening cycle, while many high-income homeowners remain locked into pre-pandemic low-rate fixed mortgages, keeping their housing costs relatively stable. Housing pressure has therefore fallen disproportionately on lower-income groups, who are predominantly renters.
Bank of America Securities notes that while the Fed Chair has expressed a desire for monetary policy to narrow this divide, evidence does not support the effectiveness of this path. A more fundamental issue is that the K-shaped economy creates a policy calibration problem: high-income groups are experiencing "re-inflation"—strong demand and firm asset prices—while low-income groups face "mild stagflation"—weak growth and compressed purchasing power. These two distinct macroeconomic environments call for diametrically opposite policy prescriptions.
If the Fed focuses too much on aggregate consumption and GDP data driven by high-income groups, it risks underestimating the plight of low-income households and maintaining an overly restrictive policy stance. Conversely, if it focuses excessively on low-income pressures and eases aggressively, it could make a policy error in a context where high-income demand remains strong and inflationary pressures persist.
Therefore, gradualism is the most prudent choice for navigating this dilemma, aligning with the Fed's recent cautious, data-dependent operational path. It is worth noting that the Fed's dual mandate focuses on maximum employment and price stability, not GDP growth or consumption spending, which objectively helps avoid policies being misled by aggregate data dominated by high-income groups.
Can Fiscal Policy Fill the Gap? Limited Room, Significant Risks
If monetary policy struggles to directly address the K-shaped split, can fiscal policy step in? Theoretically possible, but real-world constraints are significant.
Targeted fiscal support—such as providing specific transfer payments to low-income families to cushion against energy price shocks—can function as a short-term stabilizer, as seen with pandemic-era fiscal relief. However, current fiscal space is extremely limited. The U.S. fiscal deficit is set to remain above 6% of GDP. Coupled with rising interest expenses, tariff rebates (around $175 billion), potential defense supplemental spending (around $100 billion), and the recently passed immigration-related funding bill, fiscal capacity is heavily occupied.
A deeper risk is that if fiscal expansion pushes up long-term rates and term premiums, it could tighten financial conditions through channels like mortgage rates, causing secondary harm to low-income families—precisely the group the policy aims to protect. Furthermore, additional fiscal stimulus could stoke demand-driven inflation, to which low-income households are least resilient, potentially trapping them in deeper hardship after short-term support.
The effectiveness of fiscal policy in responding to K-shaped divergence is ultimately constrained by fiscal space, inflation risks, and market tolerance for the fiscal trajectory. It is not a tool that can be deployed at will.
Can the K-Shaped Split Self-Correct? Recent Signals Warrant Attention
Although structural challenges remain severe, the latest data provides a basis for cautious optimism.
Bank of America card data for the first half of June shows a narrowing gap in total consumption (excluding gas) between high- and low-income households. Concurrently, reports from the Bank of America Institute indicate a pickup in after-tax wage growth for middle- and low-income families. If this narrowing trend persists, one possible explanation is that job growth is spreading to blue-collar industries like leisure and hospitality, construction, and manufacturing—resembling the market state before the K-shaped consumption pattern emerged, when spending and wage growth for low-income families actually outpaced that of high-income families.
However, it is premature to declare a sustained reversal in the K-shaped divergence, as recent improvements may partly reflect the short-term effects of tax cuts. The firm maintains its baseline forecast for a moderate labor market recovery, contingent on continued easing in the Middle East, oil prices not breaching $90 significantly, and continued fading of tariff uncertainties.
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