As US economy drastically slows, Fed's preferred inflation gauge stays hot – likely putting rate cuts on hold

• Full-year 2025 US economic growth was 2.2%, down from 2.8% in 2024, with Q4's 1.4% rate representing a sharp decline from Q3's 4.4% rate
• Core PCE inflation remained at 3% year-over-year, still significantly above the Fed's 2% target, indicating stalled progress on reducing inflation
• The government shutdown contributed to the slowdown, causing federal spending to plunge 16.6%, though some analysts estimate GDP would have been closer to 2.4% without the shutdown impact

Summary

The U.S. economy experienced a sharp slowdown in Q4 2025, with GDP rising just 1.4% annualized—significantly below the 2.5% forecast and down from 4.4% in Q3. Full-year 2025 growth reached 2.2%, down from 2.8% in 2024.

Simultaneously, inflation remains problematic. The Fed's preferred PCE price index rose to 2.9% in December, exceeding the 2.7% estimate. Core PCE increased 3% year-over-year, well above the Fed's 2% target, signaling stalled progress on inflation reduction. Goods prices climbed 0.4% and services rose 0.3%, indicating broad-based price pressures.

Key Contributors to GDP Weakness:

• Government spending plunged 5.1%, driven by a 16.6% federal spending decline due to the government shutdown
• Weaker consumer spending and exports
• President Trump attributed at least two percentage points of the slowdown to the shutdown and criticized Fed Chair Jerome Powell

Market Implications:

The report complicates the Fed's rate-cut path. Minutes from the January Fed meeting revealed policymakers are increasingly reluctant to cut rates this year. The combination of slowing growth and persistent inflation creates a challenging "stagflation-lite" scenario, forcing hawks and doves into prolonged disagreement.

Positive Signals:

• Final sales to private domestic purchasers rose 2.4%
• Gross private domestic investment jumped 3.8%

Expert Analysis:

Chris Zaccarelli (Northlight Asset Management) noted the report will prolong Fed divisions, while Rick Gardner (RGA Investments) emphasized the Fed's "inflation problem is far from solved." Analysts expect policymakers to maintain a wait-and-see approach on future rate cuts.