Viewpoint
December 05, 2025 | 14:54
Flagging a Fourth Quarter Slowdown
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Flagging a Fourth Quarter Slowdown |
| The timing of the federal government shutdown, and the coincident pause in government economic data flows, could have hardly come at a worse time for forecasters trying to get a read on the economy going into the new year, or for the Fed. Because of the shutdown, Q3 spending and inflation data (which should have been finalized long ago) are still trickling in, and we have yet to see a preliminary third quarter GDP report for the United States. Friday’s personal income and spending report for September was important for shoring up our estimates for Q3 GDP and real consumer spending. The report pointed to a noticeable deterioration in consumer demand after adjusting for elevated inflation. The inflation mirage makes nominal retail sales and Black Friday spending appear solid on the surface, while visible cracks in real spending trends are forming underneath. |
| Real personal spending was unchanged in September while August was revised down to 0.2% from an originally reported 0.4%. On an annualized basis, real spending slipped to just 0.5% from 2.98% in August. More concerning was the drop in both real durable and nondurable goods spending in the final month of the third quarter at 6.9% and 3.9% annualized rates, respectively (Chart 1). Real personal incomes are getting pinched by higher inflation too, despite steady and stout nominal growth trends. Real disposable personal income growth averaged only 1.1% on an annualized basis over the two months through September, down from a 3.3% growth rate in July (Chart 2). As a weakening labor market, slowing immigration, and rising prices sap consumer spending power, the speed limit for real consumer spending growth will necessarily drop. Real consumer spending in Q3 will likely come in around 2.7% a.r., a modest acceleration from Q2’s 2.5% pace and the 0.6% gain in Q1. We think it will be difficult to achieve any meaningful relief on the inflation front without a more noticeable moderation in domestic demand. We do think that’s coming in the fourth quarter, despite the headlines of resilient Black Friday sales. We are forecasting an anemic real consumer spending growth rate of 1.0% a.r. in the fourth quarter and a meek 0.3% a.r. real GDP growth rate in Q4 as the government shutdown adds to the weakness in domestic demand. Surveys like consumer confidence and regional manufacturing PMIs are already pointing to a Q4 slowdown, even as surprises from harder data, much of it lagged from the third quarter, point to a more resilient economic environment (Chart 3). So, what are some of the positives that point to a rebound in growth in the first quarter of 2026, you ask? The reopening of the government will be an important catalyst for better 2.1% a.r. real GDP growth in Q1. We are also seeing an encouraging pick-up in non-defense capital goods orders (excluding aircraft) that suggest a solid growth rate for business investment to kick off 2026. Rebounding mortgage applications in November and better-than-expected pending home sales in October suggest Fed rate cuts could be increasing homebuyer interest. In short, the economic tea leaves are reading a bit like a Rorschach Test these days. We expect that will be visible in the outcome of next week’s FOMC meeting and updated dot plot. While another insurance cut of the fed funds rate is likely, FOMC participants appear to be more sharply divided than ever on what to do with rates next year, depending on which side of their dual mandate they are most concerned about today—inflation or labor market risks. |
Fed Preview: A Hawkish Cut with a Nod to Neutral |
| The FOMC is expected to reduce policy rates by 25 bps on December 10, lowering the target range for federal funds to 3.50%-to-3.75%. This marks the third consecutive action (75 bps in total) after a nine-month pause that followed 100 bps worth of easing during the final four months of 2024. We are also expecting hints that another (perhaps shorter) pause could be afoot to start 2026, hence the ‘hawkish cut’ moniker. This year’s longer pause reflected heightened economic policy uncertainty and the stagflation risks posed by tariffs. Next year’s pause should be more about policy rates approaching their nebulous neutral range and the need to be nimbler amid balancing the risks of achieving maximum employment and price stability. Currently, the policy tug of war is pulling on both sides of the dual mandate. The labor market is weak, threatening maximum employment. Although payrolls rebounded by 119k in September, two of the previous three months were negative (which usually only happens around recessions). Apart from the initial pandemic period, the latest five months (of BLS data) have registered the weakest job creation since the aftermath of the Great Recession. Meanwhile, the unemployment rate rose a tenth to 4.4% in September, the highest level since October 2021 and two-tenths above the FOMC’s latest median projection of the longer-run or ‘natural’ rate. Unfortunately, November’s Employment Situation report will be released on December 16, supplemented with a partial October report (establishment survey only, no household survey so no jobless rate). Private-sector data have revealed continued weakness through November, such as this week’s reports from ISM, ADP, and Revelio Labs (see Sal’s Thought, “Still a Low-Hire, Low-Fire World for Workers”, for more details). However, the Fed is still flying a bit blind in gauging the divergence from maximum employment. And one wonders how much of the weakness is due to AI proliferation and immigration policy, both of which are beyond the scope of monetary policy. This was one argument employed by Kansas City President Schmid in dissenting against a rate cut last confab. Meanwhile, inflation is sticky at around 3%, threatening price stability and the 2% target. Total and core PCE inflation was 2.8 y/y in September with core services ex-rents at 3.3%. Most of the three-month annualized moves were running a bit above their yearly changes. The CPI metrics were comparable: total and core 3.0% y/y, core services ex-rents 3.2% y/y, three-month changes all running hotter. Again, unfortunately, the October CPI has been canceled with the November report slated for December 18. The PCE price indices for both October and November have been postponed. With the private sector surrogates not as robust on the inflation side, the Fed will be flying even more blind in gauging the divergence from price stability. And one wonders further the extent to which policymakers’ concerns about sticky readings are being countered by the unfolding AI-related boost to productivity and labor market weakness, along with the conviction to ‘look through’ tariffs’ one-off price impacts. Given all the above, we expect a lively cut-vs.-hold debate on December 9-10. Even at the previous meeting: “Participants expressed strongly differing views about what policy decision would most likely be appropriate at the committee’s December meeting.” At that late-October confab, the vote was 10-to-2 with Governor Miran also dissenting in favor of a 50-bp move, and we expect him to vote that way again for the third straight meeting. And there is a good chance that KC’s Schmid could have some company dissenting in favor of holding. A 25-bp cut, or any policy action, requires a simple FOMC majority, so a minimum of 7 of 12 votes in the current case, which is highly probable. Going back to the 1930s, a policy action has never been voted down, although there have been more dissents at times, as many as three (the last episode was September 2019), four (October 1992), and even five (May 1983). Public comments suggest December’s dissents could be on the higher side. However, it is unclear how much of these sentiments could be appeased in casting the action as a ‘hawkish cut’… signaling more policy caution ahead and a potential pause, say, via an explicit reference to being closer to the neutral range. Indeed, this was the message delivered in the market-moving speech by New York Fed President Williams on November 21. He argued for a December rate cut (itself an impactful signal from the FOMC’s Vice Chair) “to move the stance of policy closer to the range of neutral, thereby maintaining the balance between the achievement of our two goals”. The notion of “balance” pointed to a more circumspect policy approach afterwards. In the Summary of Economic Projections (SEP) and its ‘dot plot’, we’re anticipating little change from September’s SEP. Starting with a 3.50%-to-3.75% range, the median forecast for quarter-point rate cuts in each of 2026 and 2027 should hold (we’re still in the three-cuts-next-year camp). With the increasing focus on neutral, participants might sharpen their projections of the longer-run level. The last SEP had a central tendency range of 2.75%-to-3.50%, with a median of 3.00%. We reckon there is a slight net upside risk here. Elsewhere, the other economic projections might not change meaningfully either, with the absence of up-to-date data. Finally, in the press conference, we look for Chair Powell to foster the ‘hawkish cut’ narrative, emphasizing that the Fed’s policy actions will necessarily become more cautious approaching the neutral range. |
Still a Low-Hire, Low-Fire World for Workers |
| We are still more than a week away from the long-awaited official November (and October) jobs report, but based on a stream of private-sector sources and some government figures, hiring remains weak and the jobless rate likely continues to grind higher. ADP private-sector payrolls fell by 32,000 in November, marking the third decline in four months. This was led by a 120,000 plunge among small businesses. While large firms continued to provide a partial offset to the layoffs at small shops, the latter are far more numerous and tend to generate more jobs over time. Unfortunately, they are likely having a harder time adjusting to uncertain trade policies and immigration restrictions. Also disappointing was Revelio Labs’ estimate of nonfarm payrolls, which contracted by 9,000 in November. And, both of the ISM job metrics remained in negative territory in the month. Still, some reports suggest labor market conditions might not be worsening. Initial jobless claims fell by 27,000 last week to a more than three-year low of 191,000. While the slide was likely due to the Thanksgiving holiday, the four-week moving average has been drifting down toward its quarter-century average. In addition, after spiking in October, Challenger layoff announcements returned to their 25-year mean last month (Chart 1). Neither economic conditions nor artificial intelligence were cited as main reasons for the 71,321 layoffs. Rather, they were led by restructuring efforts (including 13,000 at Verizon), which tend to be one-time drivers. |
| All told, the data suggest that official private-sector payroll gains likely remained under 100,000 in November (as in the five months to September) and may even have turned negative (as in June). The unemployment rate should either stay close to September’s level of 4.44%, as suggested by the Chicago Fed’s real-time tally for November (held down by immigration restrictions); or, more likely, edge higher due to weak labor demand. In either case, the rate would be above the FOMC’s median estimate of neutral (4.2%), pointing to ebbing inflation pressures. If policymakers are thinking along these lines, they will pull the easing trigger again next week, even if inflation is currently above target. |
