Government shutdown masks solid GDP growth
SCOTUS rules against tariffs.
Published February 20 2026
Bottom Line
The longest federal government shutdown in history last October and November, which lasted a record 43 days, subtracted 1.15 percentage points from fourth quarter gross domestic product (GDP), driving overall growth down to a much weaker-than-expected pace of 1.4% on a quarter-over-quarter (q/q) annualized basis. That compares with much stronger growth rates of 4.4% and 3.8% in the third and second quarters of last year, respectively.
That’s roughly half the pace of growth that we and others had expected. The Bloomberg consensus estimated a 2.8% increase; Federated Hermes was expecting 3.1% growth; the Blue-Chip consensus recently raised its estimate from 1.0% to 2.5%; and the Atlanta Fed lowered its “GDPNow” tracking estimate from 5.4% last month to 3.0% yesterday.
What happened? Personal consumption rose by an in-line 2.4% in the fourth quarter, which added 1.58 percentage points to overall growth. Corporate spending increased by 3.7%, which contributed 0.51 percentage points to growth. But residential construction continues to struggle, declining by 1.5% for the sixth time over the past seven quarters, which trimmed six basis points from fourth-quarter growth. As a result, private domestic final sales grew by a solid 2.4% in the fourth quarter.
But federal government spending plunged by 16.6% in the fourth quarter due to last fall’s government shutdown, which reduced fourth-quarter GDP growth by 1.15 percentage points. The Trump Administration argued this morning that the federal government shutdown cost the US “at least two points in GDP.”
Inventory liquidation was a sequentially smaller $13.6 billion last quarter, which added 21 basis points to overall growth. Finally, net trade improved in the fourth quarter, as a 0.9% decline in exports outweighed a 1.3% decline in imports, which added eight basis points to fourth-quarter growth.
Supreme Court rules against tariffs Friday morning, the Supreme Court of the United States (SCOTUS) ruled 6-3 against the Trump Administration, deciding that the International Emergency Economic Powers Act (IEEPA) does not authorize President Trump’s use of tariffs, which upholds a previous lower court ruling from the Federal Circuit. Justices Brett Kavanaugh, Samuel Alito and Clarence Thomas dissented. Stocks rallied by more than 1% in response.
While this certainly complicates the trade picture and its potential impact on future GDP growth, the Trump Administration has already crafted a “Plan B,” which President Trump may detail in his State of the Union Address next Tuesday night, if not before. Several possible planks may include:
- Section 122 – allows 15% tariffs for 150 days on countries with significant trade deficits with the US, which replaces about 80% of current tariff revenue immediately.
- Section 232 – allows tariffs on products due to a national security threat, such as steel, cars, energy and semiconductors. So, these appear to be unaffected, accounting for nearly half of overall tariff revenue.
- Section 301 – allows tariffs on a country-by-country basis, which is a time-consuming process, and it is unclear if there are limits on rates. But they could replace an estimated 90% of current tariff revenue.
- SCOTUS did not discuss whether the federal government must refund the tariff revenue already paid, with interest. If so, an estimated $150 billion or more could drop to the bottom line for S&P 500 companies.
Private domestic final sales slow in the fourth quarter This metric gauges the underlying fundamental strength of the economy, focusing on the three core elements of GDP growth, which includes personal consumption, corporate spending, and residential construction. By design, it excludes volatile inventory liquidation or restocking, net trade, and government spending. In the fourth quarter, this metric grew by 2.4% q/q, which is lower than 2.9% increases in the third and second quarters, but up from this morning’s 1.4% flash.
Inflation ticks higher The core Personal Consumption Expenditure (PCE) index (the Federal Reserve’s preferred measure of inflation) was a tick higher than expected at 0.4% m/m in December and 3.0% y/y, perhaps due to the impact on inflation from tariffs. That’s up from 2.8% in each of the previous three months and the four-year low of 2.6% in April 2025.
Federal Reserve stays on the sidelines for now? The Federal Reserve left the federal funds rate unchanged at a three-year low of 3.50-3.75% at its most recent policy-setting meeting on January 28. The Fed cut interest rates by a total of 75 basis points in September, October and December 2025 — and by a collective 175 basis points over the past two years — so it was appropriate for the central bank to pause at last month’s meeting to digest these recent cuts. Kevin Warsh will likely be confirmed to replace outgoing Chair Jerome Powell on May 15, and we are still expecting three more quarter-point cuts over the next year, which would take the terminal value of the fed funds rate down to 3.0%, with core inflation bottoming at 2-2.5%.
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