Economic tailwinds

Bottom Line

The fog enveloping US economic data is slowly lifting, as federal government bean counters get caught up after the six-week shutdown. It appears third-quarter economic growth was strong, the fourth quarter will take a temporary hit from the shutdown and next year’s first quarter will enjoy a recovery bounce. Corporate profits continue be better than expected, the Federal Reserve is engaged in a rate-cutting campaign that likely will run into next year and high-end consumers, imbued by the wealth effect, are driving solid spending. 

As we look across the proverbial valley into 2026, the midterm elections should result in additional fiscal stimulus — particularly benefitting the lower-end of the income spectrum. We expect the tax incentives from President Trump’s One Big Beautiful Bill to kick in and corporate capex spending to accelerate. In addition, America250, the winter Olympics and the World Cup soccer tournament should boost economic activity. 

Solid Christmas expected The four-month Back-to-School (BTS) retail season (measured from June through September) rose by a three-year high of 4.5% year-over-year (y/y), nearly double last year’s 2.3% gain that was the weakest results since the Global Financial Crisis. That is on top of the strong 5.0% y/y increase in “Marpril” sales during the Easter and Passover season this year —also a three-year high — versus a 3.0% gain in March and April combined last year.

Looking ahead to Christmas, the National Retail Federation (NRF) is expecting a gain of 3.7% to 4.2% during November and December versus 4.3% in those two months last year. We define the holiday shopping season more broadly as the four months from October through January, whose sales measured a 4.0% y/y gain last Christmas. Despite the well-documented bifurcation between high- and low-end consumers, the holiday shopping season has gotten to a solid start this year, driven by the beneficiaries of the wealth effect created by surging stock and home prices. According to Moody’s, the top 10% of Americans account for half of consumer spending, which in turn accounts for 70% of GDP. 

Strong corporate results The third quarter reporting season for the S&P 500 is nearly complete, and results were better than expected. Revenues rose 8.2% y/y (consensus at 6.3%) compared with a 6.4% y/y gain in the second quarter. Earnings increased 13.4% y/y (consensus at 8%) versus an 11.9% gain in the second quarter. Net profit margins increased, due to improvement in productivity and moderation in wage growth.

Labor market struggling The economic narrative is not universally positive. Over the past five months through September, nonfarm payroll gains have deteriorated to an average of only 39,000 jobs per month — including jobs losses in June and August — amounting to the weakest pace of job creation since the depths of the Covid pandemic. That compares with average monthly payroll gains of 123,000 over the first four months of 2025 and 168,000 during 2024. The Labor Department will not report November payrolls until December 16 due to the shutdown. The Bureau of Labor Statistics will not even publish an October report, though some of that data will be incorporated in the December 16 release.

True, while this week’s initial weekly jobless claims, an important leading indicator, hit a three-year low of only 191,000, that may have been impacted by the Thanksgiving holiday. But the ADP private payroll survey in November posted a much weaker-than-expected loss of 32,000 jobs (consensus was for a gain of 10,000), down from a gain of 47,000 jobs in October. ADP has lost jobs in three of the past four months, mostly at small- and medium-sized companies. 

Finally, Challenger announced sizable job cuts of 153,000 in October and more than 71,000 in November. At more than 1.1 million, that means the first 11 months of 2025 are the worst year for layoffs since the Global Financial Crisis in 2009. Seasonal hiring plans are the lowest since Challenger started tracking them in 2012. 

Another Fed rate cut on deck With the labor market deteriorating but inflation moderating, the Federal Reserve cut interest rates in September and October. We expect another quarter-point cut on December 10, with perhaps three more similar-sized cuts during 2026. That would take the fed funds terminal rate to 3.0%. Importantly, we expect more dovish leadership at the Fed after Chair Jerome Powell’s term expires in May 2026. The leading candidate is supply-side economist Kevin Hassett, currently the director of the National Economic Council.

Adjusting our forecast The equity, fixed-income and liquidity investment professionals who comprise Federated Hermes’ macroeconomic policy committee met on Wednesday to discuss the economy, including the broad impact of the federal government shutdown. Second quarter 2025 GDP rose 3.8% quarter-over-quarter (q/q), marking the strongest quarterly growth in nearly two years, compared with a decline of 0.6% in the first quarter.

• The Commerce Department will flash third quarter 2025 GDP on December 23, nearly two months behind schedule because of the government shutdown. We raised our estimate for growth from 3.1% to 3.2%, due to strong consumer spending during the Back-to-School shopping season. The Blue-Chip consensus increased its estimate from 0.9% to 2.7% (within a range of 1.7% to 3.5%); the Bloomberg consensus raised its estimate from 3.0% to 3.3%; and the Atlanta Fed raised its GDPNow estimate from 3.0% to 3.9%. 
• We reduced our forecast for fourth quarter 2025 GDP growth from 2.8% to 1.8%, while the Blue-Chip consensus left its estimate unchanged at 0.8% (within a range of -0.6% to 2.0%). The Commerce Department warned that fourth quarter GDP could be temporarily harmed by an estimated 1.3% due to the six-week government shutdown.
• Consequently, we lowered our full-year 2025 growth estimate from 2.3% to 2.2%, while the Blue-Chip consensus raised its estimate from 1.7% to 1.9% (within a range of 1.7% to 2.1%).
• After falling to a four-year low in the spring, inflation has risen recently, as tariffs have had a one-time effect on prices. We kept our year-end 2025 forecast for core CPI inflation unchanged at 3.0% (compared with actual core inflation of 3.0% in September 2025), while the Blue Chip kept its estimate unchanged at 2.8% (within a range of 2.7% to 2.9%). We reduced our year-end 2025 estimate for core PCE inflation from 2.9% to 2.8% (compared with actual core inflation of 2.8% in September, down from 2.9% in July and August 2025), while the Blue-Chip consensus left its estimate at 2.7% (within a range of 2.6% to 2.8%).
• With the government now re-opened, the Fed cutting interest rates and fiscal stimulus from the One Big Beautiful Bill, we expect that some of the fourth quarter’s lost growth will be recovered in the first quarter. So, we raised our forecast for first quarter 2026 GDP growth from 2.8% to 3.1%, while the Blue-Chip consensus also raised its estimate from 1.4% to 1.5% (within a range of 0.0% to 2.7%).
• We left our forecast for second quarter 2026 growth at 2.9%, while the Blue-Chip view was unchanged at 1.8% (within a range of 1.0% to 2.5%).
• We kept our forecast for third quarter 2026 growth at 3.0%, while the Blue-Chip consensus was unchanged at 1.9% (within a range of 1.3% to 2.6%). 
• We tweaked our forecast for fourth quarter 2026 growth lower from 3.0% to 2.9%, while Blue-Chip left its estimate unchanged at 1.9% (within a range of 1.4% to 2.4%).
• Due to the base effects from impaired growth in the fourth quarter of 2025, we reduced our estimate for full-year 2026 growth from 3.0% to 2.9%, while the Blue Chip increased its estimate from 1.5% to 1.8% (within a range of 0.9% to 2.5%). 
• We reduced our year-end 2026 estimate for core CPI from 2.7% to 2.6%, while the Blue Chip raised its forecast from 2.8% to 2.9% (within a range of 2.5% to 3.4%). We left our year-end 2026 estimate for core PCE at 2.5%, while the Blue Chip left its estimate unchanged at 2.8% (within a range of 2.5% to 3.3%).

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