Economists upgrade outlook despite labor market fragility and inflation hovering near 3%
Economic forecasters are adjusting their expectations for the American economy as consumer spending proves more durable than anticipated, even as a federal government shutdown clouds the data picture and labor markets show signs of strain. Wells Fargo Economics has revised its U.S. GDP growth projections upward, now expecting the economy to expand 2 percent in 2025 and 2.3 percent in 2026 on an annual average basis. The forecast represents a modest improvement from the firm’s September estimates, driven primarily by stronger-than-expected consumer activity in the third quarter.
“We now forecast real personal consumption expenditures advanced at a 3% annualized rate in the third quarter, twice the pace we previously had forecast,” the report states, highlighting upward revisions to prior data that revealed sustained consumer momentum despite mounting economic headwinds.
The revised outlook comes at an unusual moment for economic analysis. The federal government entered shutdown mode on Oct. 1 after lawmakers failed to pass a funding bill, halting the release of critical economic indicators. The Bureau of Labor Statistics has delayed the September employment report indefinitely, forcing analysts to rely on private sector data from sources like ADP and regional Federal Reserve surveys to gauge labor market conditions.
Consumer spending has emerged as the economy’s most reliable pillar, with third-quarter growth accelerating to an annualized 3 percent pace—matching the average annual rate from 2024. This resilience persists despite higher interest rates, weakening employment trends, and consumer anxiety over tariff-induced price increases. However, Wells Fargo cautions that slower disposable income growth and reduced credit reliance will likely dampen spending in coming months.
At the same time, the business investment picture reveals a notable divide. Companies continue pouring money into artificial intelligence infrastructure and high-tech equipment, with information processing equipment and software spending remaining robust. Data center construction has surged as part of this technology buildout. Yet broader nonresidential structures investment has contracted for six consecutive quarters through the second quarter of 2025, with private nonresidential construction spending hitting its lowest level since March 2023. Commercial real estate starts have plummeted 70.8 percent from their 2022 peak.
According to the report, labor market conditions present perhaps the clearest concern. Alternative data sources—including Federal Reserve purchasing manager indexes, Indeed job postings, and the Conference Board’s labor differential—all point to continued softness in September. Wells Fargo projects monthly job gains will average just 50,000 through year-end when excluding the impact of ending a deferred resignation program for federal workers. The unemployment rate is forecast to climb to 4.5 percent by December before easing to 4.2 percent by the fourth quarter of 2026.
The inflation picture complicates the Federal Reserve’s policy calculus: core personal consumption expenditures inflation stood at 2.9 percent year-over-year in August, well above the Fed’s 2 percent target, while tariff increases have reignited goods price inflation just as services inflation has begun moderating. Wells Fargo expects core inflation to reach 3 percent in the fourth quarter and maintain that pace through the first half of 2026 before gradually declining to 2.3 percent by the end of 2027.
Despite inflation running hot, Wells Fargo maintains that the Federal Reserve will prioritize labor market risks over temporary price pressures. The forecast calls for 25 basis point rate cuts at both the October and December Federal Open Market Committee meetings, followed by two additional quarter-point reductions in the first half of 2026. This would bring the federal funds rate to a terminal range of 3 percent to 3.25 percent by mid-2026.
Based on the report, the government shutdown itself will create technical GDP effects, causing a dip in fourth-quarter government spending that should largely reverse in the first quarter of 2026 once operations resume. The shutdown affects roughly 26 percent of the federal budget classified as discretionary spending, furloughing approximately 750,000 workers. Wells Fargo maintains its federal deficit forecasts of $2 trillion for fiscal year 2026 and $2.1 trillion for fiscal year 2027. Meanwhile, trade dynamics remain volatile—import growth reversed sharply in August, suggesting businesses completed front-loading inventories ahead of higher tariff rates. The Trump administration has announced additional tariffs on softwood lumber, furniture, and potentially trucks and pharmaceuticals, creating ongoing uncertainty for importers and supply chain managers.
Looking beyond U.S. borders, Wells Fargo revised its global GDP forecast upward to 3 percent growth for 2025, driven primarily by the more constructive U.S. outlook. China has weathered tariff pressures better than expected and remains within reach of its approximate 5 percent growth target following tariff rate reductions and trade truce extensions. Canada, however, has struggled more noticeably, with underwhelming growth expected through the third quarter and beyond. The diverging global growth picture is creating corresponding divergence in central bank policies. The People’s Bank of China has held monetary settings relatively steady, while the Reserve Bank of India nears the end of its easing cycle. The Bank of Canada and European Central Bank may deliver additional rate cuts given local employment weakness and moderating inflation. The Bank of Japan faces political complications as a new administration expresses preference for accommodative policy, though Wells Fargo still projects a 25 basis point rate hike in December.
For the U.S. dollar, Wells Fargo expects Federal Reserve rate cuts to exert downward pressure through mid-2026, particularly if Fed easing outpaces foreign central banks. The greenback should recover in the second half of 2026 as monetary easing concludes and fiscal stimulus takes hold, with concerns about de-dollarization fading as the dollar’s reserve currency status reasserts itself.
