U.S. Q3 GDP Grows at Fastest Pace in Two Years

Key Concepts

• Tariffs: Taxes imposed on imported goods, impacting trade and prices.
• Federal Reserve (The Fed): The central bank of the US, responsible for monetary policy (interest rates, etc.).
• S&P 500: A stock market index representing the performance of 500 large-cap companies in the US.
• Operating Margins/Profit Margins: Measures of a company’s profitability.
• FOMC: Federal Open Market Committee, the body within the Federal Reserve that sets monetary policy.
• Basis Points: A unit of measurement used in finance to describe percentage points (1 basis point = 0.01%).
• Prime Rate: The interest rate that commercial banks charge their most creditworthy customers.
• Real Spending: Spending adjusted for inflation.

US Economic Performance in 2025 & Global Implications

The US economy in 2025 has experienced volatility, beginning with negative growth in the first quarter, followed by recovery in the second and third quarters. However, the pattern of imports reveals a concerning trend. Imports spiked in Q1 anticipating tariffs, then declined for two consecutive quarters, currently standing at $3.6 trillion – comparable to the first half of 2024, but not indicative of strong export prospects for US trading partners.

Inflation, Interest Rates, and the Federal Reserve’s Dilemma

Inflation has cooled, but interest rates remain high, placing the Federal Reserve in a difficult position. As Chairman Powell has noted, prices are still tracking above the target rate. While some of this is attributed to tariffs, the employment situation is weak. Overall employment has been flat throughout 2025, with significant declines in employment within small and medium-sized enterprises (SMEs) – a three-month consecutive decline observed from September to November. This poses a risk, as stress in the SME sector negatively impacts employment prospects, a key concern for the Fed.

Equity Market Performance & Concentration Risk

US equity markets have been fluctuating, experiencing a significant correction in April following the announcement of high reciprocal tariffs. A subsequent partial rollback of tariffs led to a recovery. The S&P 500’s performance is largely driven by large corporations, particularly in the tech and AI sectors, creating a concentration risk. Large corporations have demonstrated adaptability to tariffs by absorbing costs through lower operating margins (profit margins were flat in Q2 and Q3) and halting hiring. This resilience allowed corporate profits to rebound in Q3. In contrast, the income of the small business sector remains flatlined, highlighting a divergence in economic performance. “Large corporations are doing well. That's why the S&P 500 is doing well,” as stated in the discussion.

Impact of Tariffs on the US Consumer & Investment

While the US consumer has shown resilience, particularly during the holiday period, the impact of tariffs is becoming increasingly apparent. Approximately 75% of tariff costs have been absorbed by companies, with only 25% passed on to consumers. However, tariff costs are now impacting the prices of equipment and software, leading to increased input costs for businesses. Investment in Q3 was flatlined, not due to a lack of spending, but because the prices of investment goods rose significantly, resulting in no increase in real spending on business investment. This lack of investment in the capital stock is expected to have negative long-term consequences for productivity.

Looking Ahead to 2026: Challenges and Potential Rate Cuts

The markets are currently consolidating after a volatile year. Looking towards 2026, underlying economic growth is projected to be closer to 2-3%, with inflation expected to fall below 3%. This scenario presents the Federal Open Market Committee (FOMC) with a potential window to reduce interest rates by 25-50 basis points in the first half of 2026. Lower interest rates would particularly benefit households and small businesses, as the prime rate (currently 3 percentage points over the federal funds rate) impacts their borrowing costs.

Notable Quotes

• “Large corporations are doing well. That's why the S&P 500 is doing well.” – This statement emphasizes the disparity in economic performance between large and small businesses.

Synthesis/Conclusion

The US economy in 2025 is characterized by volatility, a divergence in performance between large corporations and SMEs, and the growing impact of tariffs on investment. While the consumer has remained resilient, rising input costs and flatlined investment pose risks to long-term productivity. The Federal Reserve faces a delicate balancing act between controlling inflation and supporting economic growth, with potential for modest rate cuts in 2026 if inflation continues to decline. The concentration of market gains in large tech and AI stocks also presents a concentration risk that warrants attention. The overall picture suggests a slowing growth trajectory and continued uncertainty stemming from trade policies.