Markets Weigh Business Strength Against Consumer Weakness

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Equity markets stumbled this week despite an economic backdrop that continues to show signs of broadening. While concerns about consumer strain are mounting, those worries have so far been offset by ongoing strength in business investment, particularly spending tied to artificial intelligence (AI). The dominant financial market story this week, however, centered on rising debt levels and the accompanying increase in U.S. medium- and longer-term interest rates. Ironically, the AI boom itself is contributing to that rise. The significant capital required to fund AI-related investment is increasingly being financed through debt issuance, forcing investors to absorb both a growing supply of corporate debt and ever-larger amounts of U.S. Treasury issuance. After hitting 3.94 percent on February 27, 2026, the 10-year Treasury yield continued its climb this week, reaching 4.73 percent, its highest level since January 2025. The 30-year Treasury yield rose to its highest level since June 2007.

The move higher in rates has attracted the attention not only of investors but also of U.S. Treasury Secretary Scott Bessent. On Wednesday, the U.S. Treasury announced it was doubling the size of its buybacks of longer-term Treasurys, increasing purchases in the 10- to 30-year segments from $2 billion to $4 billion. While yields initially declined following the announcement, they reversed course and moved higher again on Thursday. That occurred despite Bessent’s appearance on CNBC, where he said the operation was intended to signal that the market for longer-term securities needed additional liquidity and that current yields were not “reflective of fundamentals.” He also noted that buybacks could exceed $4 billion and emphasized that the Treasury Department had a “big toolkit.” At the same time, he announced that President Trump had tasked him and Office of Management and Budget Director Russ Vought with a new initiative focused on fiscal consolidation. According to Bessent, there is a “very good chance we have seen the peak in fiscal deficits.”

These efforts follow other recent actions by the Treasury Department that appear designed to keep a lid on longer-term interest rates. Most recently, the United States participated in a coordinated operation with Japan to support the yen. As the largest foreign holder of U.S. Treasurys, Japan's need to defend its currency can create selling pressure in Treasury markets as it raises dollars to purchase yen. Supporting the yen may therefore help reduce the likelihood that Japan will need to sell Treasury holdings. Additionally, Treasury Secretary Bessent has been a strong advocate for stablecoins, a position many observers view in the context of the fact that stablecoin reserves are generally invested in short-term Treasurys.

The increased focus on rates highlights their growing importance at a time when gross U.S. government debt has surpassed $40 trillion and net interest payments have risen to more than $931 billion during the first 10 months of the current fiscal year. With the Federal Reserve expected to raise, rather than lower, interest rates, concerns are growing about the future path of borrowing costs and the implications for both the economy and financial markets. Those concerns are especially relevant given that higher rates and elevated inflation have already weighed on consumers and the housing market. They also raise questions about the durability of the AI investment boom, which requires substantial amounts of capital at a time when that capital is becoming increasingly expensive.

Against this backdrop, economic data released this week continued to point to a resilient U.S. economy. The S&P Global U.S. Purchasing Managers' Index (PMI) rose to its highest level since April 2022, supported by strong employment growth and moderating (though still elevated) price pressures. Industrial production data showed manufacturing output increasing 0.2 percent month over month and climbing to within 0.3 percent of its March 2022 peak, before the sharp rise in interest rates. The improvement was broad based, with 11 of 18 manufacturing groups posting gains. However, the strongest growth continued to come from business equipment tied to AI. Output in that category rose 0.8 percent month over month and is now up 6.6 percent year over year. Demand for computers and electronics remained particularly strong, with production increasing 1.9 percent month over month and standing 9.9 percent above year-ago levels. In contrast, consumer goods production fell 0.4 percent month over month, leaving year-over-year growth at -1.8 percent.

That divergence underscores the growing questions surrounding the health of the U.S. consumer following July’s weak retail sales report. Persistent pressure from negative real wage growth; elevated borrowing costs on credit cards, auto loans, and student debt; along with a historically low savings rate of 2.7 percent appear to be weighing on household spending. Additional evidence emerged this week when Walmart (WMT), the nation's largest retailer, reported comparable-store sales growth of 2.6 percent, its slowest pace in more than six years. While management attributed part of the slowdown to federal drug-price negotiations that negatively affected its health and wellness segment, the results nevertheless raised concerns about consumer demand. Company executives specifically pointed to the impact of gasoline prices on spending behavior.

The U.S. economy continues to move forward, providing support for U.S. equity markets. Next week's release of Personal Consumption Expenditures (PCE) inflation data and Fed Chair Kevin Warsh’s appearance at Jackson Hole should offer additional insight into how Fed policy may influence shorter-term interest rates. While the Fed remains an important part of the interest-rate discussion, fiscal policy is playing an increasingly significant role in shaping medium- and longer-term borrowing costs. If rates continue to move higher, the risks facing both the economy and financial markets are likely to increase. Investors will also receive an important update on the state of AI spending when NVIDIA (NVDA), the largest U.S. company by market capitalization, reports earnings. Given the heightened uncertainty surrounding the future path of interest rates and their implications for both the consumer and the AI investment cycle, we continue to believe diversification remains one of the most important tools available to investors.

Wall Street wrap

Business activity accelerates to strongest pace since 2022

Economic growth appeared to gain momentum in August as the S&P Global U.S. PMI Composite Index rose to 56, up from 54.5 and its highest level since April 2022. The increase was driven largely by the services sector, where the Services PMI reached 56.8, matching its highest level since March 2022. Manufacturing activity also remained in expansion territory, with the Manufacturing PMI registering 53.2, though that marked a five-month low.

According to the survey, manufacturing production was constrained by shortages of raw materials and supply chain delays. Firms also reported less inventory building as concerns tied to the Middle East conflict have faded. Despite those near-term challenges, future output expectations rose to their highest level since November 2025, suggesting businesses remain optimistic about the outlook.

Labor-market conditions also remained supportive. Employers added workers at the fastest pace since January 2025, marking the second-strongest hiring period of the past four years. Hiring increased across both manufacturing and services, although service-sector firms accounted for the bulk of the gains.

Price pressures continued to ease, particularly with respect to selling price inflation. However, input costs remained elevated by historical standards as businesses continued to cite high energy prices, supply-chain disruptions, and tariffs as sources of cost pressure.

As Chris Williamson, chief business economist at S&P Global Market Intelligence, noted: “U.S. business is booming, with firms reporting the fastest output growth for over four years so far in the third quarter as the expansion picked up further momentum in August. The survey data for the third quarter [is] currently pointing to annualized growth approaching 3 percent, up solidly from the 1.5 percent pace seen in the second quarter.”

Industrial production points to continued business spending strength

Industrial production increased 0.2 percent in July, while the prior month's reading was revised higher from a gain of 0.1 percent to 0.3 percent. The manufacturing component, which accounts for the largest share of industrial production, also rose 0.2 percent after June was revised from unchanged to a 0.3 percent increase.

Manufacturing output is now up 1.2 percent year over year and has improved notably in recent months. Even so, production remains 0.3 percent below its March 2022 level prior to the Fed’s rate-hiking campaign.

While overall manufacturing activity improved, the details painted a more mixed picture. Consumer goods production fell 0.4 percent during the month and is now down 1.8 percent from a year ago, a sign that higher borrowing costs and negative real income growth continue to weigh on household demand.

By contrast, business investment remained a key area of strength. Output of business equipment rose 0.8 percent and is now up 6.6 percent year over year. Much of that growth continues to be driven by strong demand for computers and electronics, where production increased 1.9 percent during the month and stands 9.9 percent above year-ago levels. Reflecting the ongoing conflict in the Middle East, defense production also rose a strong 1.8 percent and is now up 6.8 percent year over year.

Housing activity remains under pressure

The housing market continued to show signs of strain as higher mortgage rates and affordability challenges weighed on new construction activity.

Housing starts fell to an annualized pace of 1.239 million units, down from 1.415 million the prior month. Excluding May’s 1.182 million pace, July marked the slowest rate of housing starts since the pandemic-affected months of April and May 2020 and, before that, March 2019.

Weakness was particularly evident in the single-family segment, where starts declined to 808,000 units, the slowest pace since 2022. Single-family construction remains firmly in a downtrend. Multifamily starts also fell to 431,000 units, although that segment remains in an uptrend after bottoming in mid- to late 2024.

Permits offer a potential silver lining

While construction activity softened, permitting data offered a somewhat more encouraging signal for future homebuilding activity.

Building permits increased 5 percent to an annualized pace of 1.443 million units, the highest level since February. Single-family permits rose to 894,000 from 872,000, while multifamily permits increased to 549,000 from 502,000.

The increase suggests builders continue to position themselves for future demand, although actual construction activity remains constrained by affordability challenges and elevated financing costs.

Homebuilder sentiment remains depressed

Builder confidence improved only modestly in August. The National Association of Home Builders/Wells Fargo Housing Market Index rose to 35 from 34 but remained firmly below the 50 threshold, indicating that more builders view conditions as poor rather than good. The index has remained below 50 since May 2024.

The weakness in builder sentiment continues to reflect a difficult operating environment. As National Association of Home Builders Chief Economist Robert Dietz noted, “August marked the 16th straight month that at least 30 percent of builders reported cutting prices to support demand, as well as the 16th consecutive month with the NAHB/Wells Fargo Housing Market Index (HMI) below 40.”

Taken together, this week’s housing data suggests that while permitting activity may be stabilizing, elevated mortgage rates and affordability pressures continue to weigh heavily on both builders and potential homebuyers. Meanwhile, the broader economy remains supported by resilient business activity and ongoing investment spending, particularly in areas tied to artificial intelligence and technology infrastructure.

The week ahead

Tuesday: The Conference Board will release its August Consumer Confidence Index at 10:00 a.m. ET. We will be watching whether household sentiment continues to improve or remains constrained by concerns about inflation, labor market conditions, and economic uncertainty. The Census Bureau will also release July New Home Sales data at 10:00 a.m. ET. We will be monitoring demand for newly constructed homes and pricing trends for insight into whether lower mortgage rates are beginning to provide support for the housing market. In addition, the Richmond Fed will release its August Manufacturing Survey, which will provide another look at business activity and conditions across the industrial sector.

Wednesday: The Bureau of Economic Analysis will release its second estimate of second-quarter GDP growth at 8:30 a.m. ET, alongside July Personal Income and Spending data and the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) Index. We will be focused on whether economic growth remains resilient and whether inflation continues to move closer to the Fed’s target. Given the importance of PCE in shaping monetary policy expectations, these reports could provide important clues about the future path of interest rates.

Thursday: The Department of Labor will release its weekly Initial Jobless Claims report at 8:30 a.m. ET. We will be watching for signs of any meaningful change in labor market conditions, as claims remain one of the timeliest indicators of employment trends. At the same time, investors will be closely monitoring commentary from the Fed’s annual Jackson Hole Economic Symposium, where policymakers often provide insight into their views on inflation, economic growth, and the outlook for monetary policy.

Friday: The University of Michigan will release its final August Consumer Sentiment Index at 10:00 a.m. ET. We will be paying close attention to both the headline reading and consumers’ inflation expectations, as shifts in attitudes toward future price growth can influence spending behavior and factor into the Fed’s assessment of inflation risks. We will also continue monitoring developments from the Jackson Hole symposium, particularly any remarks from Fed Chair Kevin Warsh, who takes the stage at 10:00 a.m. ET, that could alter expectations for interest rates and the broader economic outlook.

Frequently Asked Questions

Why are rising interest rates important for markets?

Rising interest rates can increase borrowing costs for consumers, businesses, and the government. When rates move higher, they can weigh on areas of the economy that depend on financing, including housing and business investment, while also creating competition for stocks as bonds offer higher yields.

What is driving the recent increase in longer-term rates?

The article points to a combination of growing debt issuance, elevated U.S. Treasury supply, and capital needs tied to artificial intelligence investment. As businesses and the government issue more debt, investors may demand higher yields to absorb that supply.

How is the consumer affecting the economic outlook?

Consumer spending remains a key area to watch. The article notes that higher borrowing costs, negative real wage growth, and a low savings rate appear to be putting pressure on households, while recent retail data has raised questions about the strength of demand.

Why does diversification matter in this environment?

Diversification can help investors balance opportunity and risk when the outlook is uncertain. With business activity still resilient but risks building around rates, consumers, and the artificial intelligence investment cycle, spreading exposure across asset classes and sectors may help reduce reliance on any single driver of market performance.

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