US Economy Faces Crosscurrents: Strong GDP Growth but Weakening Labor Market

The U.S. economy enters 2026 sending mixed signals. Real GDP grew at an impressive annualized rate of 4.4% in Q3 2025, yet job creation slowed dramatically to just 79,000 in Q4 — less than one-fifth the pace of a year earlier. The Congressional Budget Office projects 2.2% GDP growth for 2026, but the gap between headline growth numbers and underlying labor market weakness is widening.

The Two Faces of the Economy

Despite GDP rising at a 3.4% annualized pace in 2025, the economy generated only 79,000 jobs in Q4, a stark contrast to the robust employment growth seen in prior years. Unemployment rose from 4.1% to 4.4% in 2025, indicating labor demand weakened more than labor supply. However, for those with jobs, wages still outpaced inflation by around 1%, and layoffs remained historically low.

Inflation Pressures Persist

Inflation, as measured by the PCE price index, is expected to slow from 2.8% in 2025 to 2.7% in 2026. Core price pressures eased in Q4 2025, with monthly core goods prices flat on average. However, Goldman Sachs projects the current tariff regime will raise inflation by 1% between the second half of 2025 and the first half of 2026 relative to its counterfactual path.

"Consumer confidence dropped to recession levels in December, with concern about both inflation and the labor market rising in tandem for the first time since the 1970s." — KPMG Economic Compass, January 2026

Consumer Spending Resilience

Real personal consumption expenditures rose 3.2% annualized in Q4 2025, demonstrating continued consumer resilience. However, consumer spending growth is expected to moderate to 2.2% in 2026, below the 2.6% expected in 2025. The simultaneous rise in inflation and labor market concerns marks the first time both have increased together since the 1970s stagflation era.

Federal Reserve on Hold

The Federal Reserve has paused rate cuts, with officials waiting for better economic data following disruptions from the 42-day government shutdown. KPMG expects only three rate cuts in 2026, starting in June. The current federal funds rate of 4.25%-4.50% is viewed as slightly restrictive, but tariff-driven inflation uncertainty is keeping the Fed cautious.

Some forecasters expect average payroll gains to rise to 70,000 per month in 2026, more than double the 32,000 average in 2025, with wages expected to climb 2.3%. The CBO projects the 2025 reconciliation act will boost consumer spending and private investment, potentially accelerating growth in the second half of the year.