The narrative of a "soft landing" for the US economy heats up again! Consumer spending drives Q3 GDP to its fastest growth in two years.

The U.S. economy, measured by GDP indicators, expanded at the fastest pace in two years in the third quarter, thanks to resilient consumer and business spending, as well as more stable trade policies compared to the second quarter. However, some economists were quick to warn after the GDP announcement that this strong growth momentum is unlikely to continue into 2026. This somewhat implies that the sudden surge in GDP against the backdrop of struggling non-farm employment data strengthens expectations for a "soft landing", but does not indicate that the U.S. economy has fully achieved the soft landing trajectory that Federal Reserve officials have been eagerly anticipating. Data released by the Bureau of Economic Analysis (BEA) on Tuesday showed that the initial estimate of U.S. Gross Domestic Product (GDP) for the third quarter, adjusted for inflation - a measure of the value of goods and services produced in the U.S. - rose by 4.3% at an annual rate, well above economists' general expectation of 3.3%. The previous quarter (second quarter) saw a growth of 3.8% quarter-on-quarter, also supported by strong consumer spending. Following the government shutdown, the BEA's initial estimate of GDP scheduled for October 30 was canceled. The agency typically releases three estimates of quarterly growth - continuously adjusting GDP data as more data becomes available - but during this record-long shutdown period, it will only release two estimates. This means that the next release of Q3 GDP might be the final value after the third quarter GDP is validated. After the report was released, U.S. Treasury yields fell while futures for the three major stock indexes continued to decline, primarily due to expectations that the strong consumer spending-driven economic growth in 2026 would weaken expectations for a Fed rate cut. However, the good news is that the narrative logic of the "Goldilocks-style soft landing" for the U.S. economy still makes sense. The delayed release of this "report card" shows that the U.S. economy, especially consumer spending which accounts for as much as 70% of GDP calculation, maintained strong growth momentum in the middle of the year, highlighting continued strong consumer spending and increased demand following the reduction of President Donald Trump's most punitive tariffs in the second quarter. Although the government shutdown is expected to drag down U.S. economic growth in the fourth quarter, economists generally expect that consumer spending will see a mild rebound in 2026 due to potential tax refunds for residents and an expected Supreme Court ruling that may overturn Trump's widely imposed global tariffs. The latest Fed projections echo this view. Fed Chairman Jerome Powell stated at the December monetary policy press conference that supportive fiscal policy, strong AI data center spending by tech giants, and robust consumer spending resilience are the main factors the Fed expects to accelerate U.S. economic growth next year. The latest FOMC dot plot shows that Fed policymakers generally expect only one more rate cut in 2026 after three consecutive rate cuts at the end of this year. Part of the reason why some Fed officials are cautious about further significant cuts in borrowing costs is because inflation still remains above their long-term target of 2%. The inflation portion of this latest GDP report shows that the Fed's preferred inflation gauge - the core Personal Consumption Expenditures (PCE) price index, which excludes food and energy - rose by 2.9% in the third quarter (annualized quarterly basis) compared to the previous quarter, in line with expectations but up from 2.6% in the previous period. BEA has not yet rescheduled the specific release dates for October or November monthly PCE data. This GDP data also shows that consumer spending, the main engine of U.S. economic growth, grew by 3.5% at an annualized quarterly rate, higher than the general expectation of 2.7% among economists, which may reflect strong service spending in the third quarter, including healthcare and international travel. Spending on motor vehicles, however, unexpectedly declined. Weaker labor market conditions and relatively higher cost of living pressures, possibly due to Trump's tariff policies, will be obstacles for U.S. consumers in 2026. This combination has led to a more noticeable divergence in consumer spending between different income groups - with cooling consumer spending among middle and low-income groups, while high-income consumers continue to spend lavishly thanks to the enormous wealth generated by the ongoing bull market in U.S. stocks. Business investment in the U.S. in the third quarter grew by 2.8% at an annualized quarterly rate, mainly driven by strong investment in heavy asset equipment, especially in the computer category. Additionally, investment in large-scale AI data centers that support AI computational power infrastructure reached a new record high. Another data released on Tuesday showed that U.S. October orders for business equipment fell more than expected. Shipments of non-defense capital goods, including aircraft (which are directly included in the equipment investment portion of GDP), were stronger than expected by economists, indicating that there is still some momentum entering the fourth quarter. After experiencing fluctuations in the first half of the year, net exports contributed about 1.6 percentage points to GDP growth. Goods and services produced outside the U.S. are subtracted when calculating GDP but are included in consumption. Inventories and residential investment both weighed on economic growth in the third quarter. As trade and inventory fluctuations have distorted GDP data this year, economists are paying more attention to final sales to domestic private consumers, a better indicator of consumer demand and business investment - this indicator rose by 3%, the largest increase in a year. Following the release of the GDP data, Diane Swonk, Chief Economist at accounting firm KPMG, said, "This is the strongest six-month growth since the end of 2023, but most people don't feel that way. Consumers are still spending and investments in data centers are substantial, but we are in a very strange situation where the economy is growing, but not creating jobs." "This report, which should have been released in October, is old news and the market expects very weak, even stagnant, fourth quarter economic growth, so there is not much to celebrate," said Chris Ruppke, Chief Economist at financial markets research firm FwdBonds. The narrative of a "soft landing" for the U.S. economy has been strengthened, but expectations for rate cuts have cooled. Morgan Stanley's outlook report for the U.S. economy in 2026 shows that the effects of the OBBBA tax cut bill passed by the Trump administration in 2025 (known as the "big and beautiful" bill) will strongly drive economic growth starting in 2026. This, combined with temporary inflation disturbances caused by Trump's tariff policies, will gradually dissipate as short-term inflation fades, and the construction of AI data centers centered around AI computational power infrastructure by tech giants such as Microsoft and Google will collectively drive the U.S. economy towards a "Goldilocks-style soft landing" of moderate growth macro environment in 2026. The so-called "Goldilocks" style U.S. macroeconomic environment refers to an economy that is neither too cold nor too hot, maintaining moderate growth in GDP and consumer spending, stable "moderate inflation trends" over the long term, and benchmark interest rates on a downward trajectory. In its latest U.S. economic outlook report, Morgan Stanley predicts that the U.S. economy will gradually move out of high uncertainty in 2026 and return to a positive trajectory of "moderate growth". While the latest third quarter GDP does strengthen the narrative of a "soft landing", it significantly cools expectations for Fed rate cuts. Some Wall Street analysts are now beginning to predict that the Fed may pause its rate cuts next year due to overheating of the economy. Following the latest quarterly GDP and PCE releases, rate futures traders have significantly reduced their expectations for Fed rate cuts in 2026, with the "CME Fed Watch Tool" showing that the market now expects only two rate cuts instead of three - possibly in March and September.