The last of the major economic data for 2025 presents a rich juxtaposition of where the economy stands and public anxiety about its direction.
The economy slowed to 1.4% in the fourth quarter, which is below its 1.8% long-term trend, while the personal consumption expenditures price index, the Federal Reserve’s preferred gauge of inflation, stands at 2.9%. The core PCE—the better long-term predictor of inflation—increased by 3%.
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The effect of the extended government shutdown last fall showed up In the GDP data. Without that shutdown, top-line GDP would have been 2.4%.
And despite the noise in the trade data caused by policy unpredictability out of Washington, core GDP expanded at 2.4%, which is what final sales to private domestic purchasers—our preferred GDP metric—implies.
In the end, underlying growth continues to be solid even if unequal distribution of that growth underscores the discontent in the economy driven by rising inflation.
While we are careful to note that GDP data provides indispensable insight into consumption, investment and production, it does not always present an accurate portrait of how we live.
And Friday’s data reflects the uneasy acceptance of how 3% inflation may now be the norm among investors, the public and some policymakers, and lies at the heart of the discontent that has set in.
Consider service inflation. It has averaged just above 3.4% for the past six months and for our money that is the best indicator of where the public lives as opposed to the various rates of inflation and disinflation in other aggregates.
The drawing down of savings to support consumption, the tapping of credit lines to make ends meet and the lack of growth in disposable income once adjusted for inflation are but three more indicators of why public anxiety is increasing.
A deeper look in the data reveals this dynamic: Real final sales increased by 1.2%, gross domestic purchases increased by 1.3% and final sales to domestic purchasers advanced by 1.1%. These are all examples of how for some domestic households and small businesses, GDP is divorced from the top-line increases in overall consumption, investment and production.
That is why the 1.4% increase in GDP demands more context that the 2.9% increase in PCE inflation and the 3% rise in core inflation provide.
Policy implications
The policy implications of Friday’s growth and inflation data are straightforward.
The Federal Reserve is not going to be comfortable reducing its policy rate with core inflation advancing by 3%—a rate that is likely to move higher in the January reading—and core growth, or real final sales to private domestic purchasers, increasing at a 2.4% pace.
At this point we just do not see a near-term rate cut given until and if Kevin Warsh, the nominee to succeed Fed Chair Jerome Powerll, is confirmed. And given the fiscal tailwind that will bolster first half demand, we just do not see the logic of an argument to cut rates.
The data
The most interesting aspect of the report was American household consumption, which increased by 2.4% because of a 3.4% increase in demand for services. But outlays on durable goods declined by 0.9%, which more than offset the increase of 0.4% in non-durable goods.
Overall goods spending declined by 0.1%.
Higher tariffs led to stress across household spending at the lower end of the market, which resulted in weak outlays on goods.
The inventory front-running that took place before sweeping tariffs were announced last April ran its course at the end of last year, and we will see further passing through of price hikes as inventory accumulation resumes.
This dynamic is why one should keep a sharp eye on core inflation which advanced at a 0.4% rate in December and by 3% annually. Based on recent data, that annual core inflation reading should increase to at least 3.1% in January.
Gross private investment increased by 3.8% to close out the final quarter, fixed investment increased at a solid 2.6% and there was a 3.7% rise in non-residential investment.
The major cause of this growth in the investment category was the 3.2% increase in equipment spending and a 7.4% increase in outlays on intellectual property; both of which are productivity-enhancing capital expenditures. Investment in structures declined by 2.4%. Residential investment dropped by 1.5%.
Exports declined by 0.9% while imports dropped by 1.3%, all of which supported a 0.8% increase in overall GDP.
Government consumption declined by 5.1% on a 16.6% drop in federal spending, defense outlays dropped by 10.8% and nondefense fell by 24.1%. All of those categories more than offset a 2.4% rise in state and local spending.
The decline in overall government spending provided a .90 percentage point drag on growth while the drop in federal spending resulted in a 1.15 percentage point drag on economic activity in the fourth quarter. Inventories provided a .021 percentage point increase in growth.
