Written by Steve Andrews
A New Economic Playbook
As we move into 2026, the central question is no longer whether the economy follows traditional signals like the yield curve or leading indicators, but whether we are prepared to navigate by a new set of rules. The past year challenged long-held assumptions. Economic headlines were often conflicting, government data releases were inconsistent, and many traditional indicators proved less reliable. Beneath the surface, however, structural forces such as rising productivity and evolving monetary dynamics shaped a fundamentally stronger economic backdrop.
Growth Defies Expectations
Despite weak sentiment readings from consumers and small businesses, economic growth accelerated in the second half of 2025. After a trade-deficit-related slowdown in the first quarter, GDP expanded 3.8% in the second quarter and 4.1% in the third quarter. The Atlanta Fed’s GDPNow model currently estimates fourth-quarter growth at 5.1%. While historically optimistic, this forecast reflects improving productivity trends and a sharp October decline in the U.S. trade deficit, which fell to $29.4 billion as exports increased and imports declined. Because net exports are a direct input to GDP calculations, this shift provided a meaningful boost to reported growth.
Labor Market - Slower Growth, Continued Stability
Job growth moderated in 2025, with nonfarm payrolls increasing by 588,000 for the year, compared to 2 million in 2024. December payroll gains totaled 50,000, consistent with subdued monthly averages. Government employment declined over the year, driven largely by reductions at the federal level, while private-sector job growth remained modest.In contrast, the Household Survey, which captures employment trends among smaller businesses and startups, showed stronger gains. Employment increased by 2.4 million over the year, contributing to a decline in the unemployment rate to 4.4% in December. Private payroll data from ADP reflected a similar pattern, with job gains averaging just over 51,000 per month.
Despite slower hiring, labor market stability remains intact. Weekly unemployment claims continue to run near multi-decade lows, and announced layoffs declined sharply in December. Voluntary quits remain elevated, indicating continued worker confidence. Wage growth above 4.0% continues to exceed inflation, supporting real income gains.
Consumer Sentiment vs. Consumer Behavior
The disconnect between how consumers feel and how they spend persisted throughout 2025. Survey-based measures of confidence weakened late in the year, with a higher share of respondents reporting concerns about job availability. Yet consumer behavior remained resilient. Real consumer spending rose 3.5% in the third quarter, and year-over-year retail sales growth exceeded 7.0% in December.
This strength is supported by underlying fundamentals. Wage growth outpaced inflation, and U.S. household net worth reached a record $181.6 trillion in the third quarter. Consumer balance sheets, rather than sentiment indicators, continue to be the primary driver of spending activity.
Productivity - The Key Growth Driver
Rising productivity remains the most important factor explaining solid GDP growth amid slower job creation. In the third quarter of 2025, U.S. productivity increased 4.1%, the fastest pace in two years, as output expanded significantly while hours worked grew only modestly.
Manufacturing productivity also improved, led by durable goods production, as firms increased output while using fewer labor hours. Business investment strengthened as well, with core capital goods orders rising 3.1% year over year, reflecting increased demand for machinery, electrical equipment, and technology. Productivity gains are increasingly offsetting labor constraints and supporting longer-term growth potential.
Global Events and Market Sensitivity
Early 2026 has brought several geopolitical developments that captured market attention and contributed to short-term volatility. Heightened global tensions have supported higher prices for energy and precious metals, reflecting increased uncertainty rather than changes in underlying economic fundamentals.
Markets are also monitoring an upcoming Supreme Court decision related to existing trade policy measures. Depending on the outcome, the ruling could have fiscal and market implications, including potential adjustments to previously collected tariffs. While the timing and impact remain uncertain, these developments underscore the role of policy clarity in shaping near-term market sentiment.
Interest Rates and Federal Reserve Outlook
U.S. interest rates have remained relatively stable, with the 10-year Treasury yield trading in a narrow range between approximately 4.15% and 4.20%. With inflation still running above the Federal Reserve’s long-term target and job growth moderating but not contracting, the likelihood of a near-term rate cut appears limited.
Lower policy rates would ease financing conditions for smaller businesses, particularly those reliant on short-term credit for inventory and receivables. However, absent a sustained decline in long-term yields below 4.00%, further policy easing may take time.
Market Continue to Signal Confidence
Equity markets continue to reflect confidence in the broader economic outlook. As fourth-quarter earnings season begins, market performance has broadened beyond a small group of large technology stocks, with a wider range of companies contributing to gains.
While investor enthusiasm around artificial intelligence has moderated, productivity improvements linked to technology adoption are increasingly evident in corporate earnings. Rising productivity, low unemployment, and improving earnings visibility have contributed to upward revisions in 2026 earnings growth expectations for the S&P 500, now approaching 15%. Overall, market signals continue to suggest that recession risks remain low.
