Economic Outlook - January 2026
- The U.S. economy grew above expectations in the third quarter (Q3) of 2025. Gross Domestic Product (GDP) expanded 4.3% in Q3, and this growth rate was well ahead of forecasts for an increase of 3.2%. It also represented an acceleration from 3.8% growth in the second quarter of 2025. Despite dour consumer sentiment indicators and a disparity between lower income and upper income households, consumer spending led the way in Q3. Net exports were also an important contributor to Q3 growth; however, trade figures in recent quarters have been subject to cross currents due to tariffs. Current estimates for GDP in the fourth quarter of 2025 are for growth of 2.5%. Looking ahead, we expect the U.S. economy will continue to grow in 2026, but at a slower pace, with annual forecasts in the 1.8% – 2% range.
- Consumer spending accounts for roughly 70% of U.S. GDP. The November – December holiday shopping season is a pivotal period for consumer spending, as approximately 19 – 20% of retail spending occurs during this time (according to the National Retail Federation). Overall, the holiday shopping season exceeded expectations. Consumers, though, were value driven and motivated by promotions and discounts. They also relied on credit for purchases and Buy Now, Pay Later programs were popular. Online purchases continue to grow at a faster rate than overall retail sales, and shoppers are also utilizing the internet to do research before making their purchases. In sum, U.S. consumer spending has enabled the economy to sustain growth in spite of ongoing tariff uncertainty and a moderating labor market.
- In the Q3 2025 GDP report, the growth rate of business investment slowed to 2.8% from a 7.2% increase in Q2. The biggest trend driving growth in capital expenditures is the continued and accelerating spending on artificial intelligence, including equipment needed to build out data centers. According to Dell’Oro Group, a market-research firm covering the data center industry, the year-over-year increase in data center capital expenditures in Q3 was 59%. In addition, the four large providers of artificial intelligence technology, Amazon, Microsoft, Google and Meta, raised their 2025 capital spending guidance to almost $400 billion combined during their Q3 quarterly earnings reports. Investments in artificial intelligence and data centers have become so large that some economists are estimating the impact of this spending on overall GDP, rather than just the business investment category.
- The Federal Reserve Open Market Committee (FOMC) lowered short-term interest rates by 0.25% at its December meeting, bringing its target range for the federal funds rate to 3.5% – 3.75%. After keeping rates unchanged throughout the first eight months of 2025, the December cut marked the third reduction since September. The cumulative total of a 0.75% decrease is the Fed’s response to a softening in labor markets. However, complicating things for the Fed is that inflation remains above its 2% target. In 2026, the Fed will be navigating a fine line between its dual mandates of maximum employment and stable prices. Current forecasts are for the Fed to lower short rates one or two times in 2026, but incoming data could result in a need for adjustments. The FOMC next meets on January 28 – 29.
Sources: Dow Jones Publishing, FactSet, Bloomberg, U.S. Federal Reserve of Atlanta, Yardeni Research
Disclosure: This commentary reflects the opinions of Welch & Forbes based on information that we believe to be reliable. It is intended for informational purposes only, and not to suggest any specific performance or results, nor should it be considered investment, financial, tax or other professional advice. It is not an offer or solicitation.
For more information, call 617-557-9800, or email info@welchforbes.com.