GDP growth in the fourth quarter was extraordinarily weak at just 0.5 percent. The main factor depressing growth was a 16.6 percent decline in federal spending, which subtracted 1.16 percentage points (p.p.) from growth in the quarter. It’s worth noting that growth in the quarter still would have been weak, at 1.7 percent, even without the negative contribution from the federal government sector.

Part of the drop in federal spending will be reversed, as it was due to the shutdown that started on October 1 and continued to the middle of November. However, most of the decline will not be reversed. It was attributable to the fact that many DOGE layoffs first took effect in October.

Nonetheless, the federal government will likely be a major contributor to first quarter growth, both because of the bounce back from the shutdown, but also due to the effect of the war in Iran. This should push GDP growth above 2.0 percent for the quarter, roughly in line with the average for 2025.

Consumption Growth Likely to Be Led by Health Care

Consumption grew at a 1.9 percent annual rate in the fourth quarter, driven by a 2.7 percent increase in service consumption. Goods consumption grew at just a 0.3 percent rate. There is likely to be a similar story in the first quarter.

Consumption of both durable and non-durable goods will be close to flat in the quarter. The data for March looked surprisingly strong after very weak numbers for January and February, but goods consumption for the quarter is still not likely to venture far into positive territory.

It is interesting that durable goods consumption picked up in March after the war started and the price of gas soared. While it’s possible that consumers suddenly felt more optimistic about their financial situation, it may also have been the result of consumers looking to buy big ticket items before prices rose further. If that proves to be the case, we can expect purchases of durable goods to slow in the months ahead.

Service consumption will again grow by close to 3.0 percent, with health care being the biggest factor. Health care expenditures will grow at close to a 4.0 percent rate for the quarter. Other categories of service spending will be considerably weaker.

Spending on housing services grew at 1.9 percent rate in the fourth quarter; it is likely to grow slightly faster in the first quarter. Spending on food services and accommodations fell at a 1.2 percent rate in the fourth quarter, it will again be negative in the first quarter. Transportation and recreation services will both show near zero growth.

Non-Residential Investment Will Provide a Boost to Growth in the Quarter

Non-residential investment grew at a 2.4 percent rate in the fourth quarter. It will likely grow at closer to a 7 percent rate in the first quarter. This will all be in the equipment and intellectual property products components, as the structure component will continue to slide. Investment in non-residential structures has been falling since the first quarter of 2024, as the factory boom earlier in the recovery wanes.

The rise in spending on equipment and intellectual property products is being driven by the data center boom. This will likely continue for the immediate future, although shortages of some components as well as hostility to construction in many areas will slow growth.

Housing Construction Will Decline Again

Residential construction was negative all through 2025, falling at a 1.7 percent annual rate in the fourth quarter. It is likely to show a similar decline in the first quarter. High interest rates continue to be a drag on growth in the sector.

Net Exports Will be a Modest Drag on Growth

Since Trump’s election trade has had a large effect in first slowing and then boosting growth. In the first quarter of 2025, net exports subtracted 4.68 p.p. from growth, as people bought cars and other big-ticket items and imports increased in anticipation of tariffs. This was reversed in the second quarter, when net exports added 4.83 p.p. to growth. Net exports were again a big positive in the third quarter, adding 1.62 p.p. to growth. The effect turned negative in the fourth quarter, when net exports subtracted 0.22 p.p. from growth.

The reason for the decline was a 1.7 percent drop in goods exports and a 5.7 percent drop in service exports. Imports also fell modestly, but not enough to offset the drop in exports. This is likely a story of foreigners moving away from US products in response to the Trump administration’s aggressive use of tariffs and foreign policy more generally.

There will likely be a comparable decline in exports in the first quarter. The Iran war will likely accelerate this movement, but it will be too early to see the effects in the quarter’s data.

Government Spending Provides a Large Boost to Growth

State and local spending, which accounts for more than 60 percent of government spending, has been rising at close to a 2.0 percent annual rate. This will again be the case in the first quarter. As noted earlier, there will be a bounce back in federal spending, as workers idled during the shutdown are back at work in the first quarter.

There will also be a boost to federal spending from war-related spending in March. While this will not be large enough to reverse the 16.6 percent decline in the fourth quarter, federal spending will likely rise in the range of 6-8 percent. This means that government spending in aggregate will rise at 4-5 percent pace, adding around 0.6 p.p. to growth for the quarter.

Inflation Will Rise in the Quarter

There was evidence of increased inflationary pressure in the February producer price index and imported goods price index, before the start of the war. The war will increase inflationary pressures, most immediately in energy, but also in other areas where the curtailment of shipping from the Persian Gulf is leading to shortages.

There will not have been time for these pressures to have been passed through to consumers in March, but we are clearly looking at a situation where inflation is going in the wrong direction.

Growth Still Respectable, but Foundations are Shaky

The overall growth rate for the quarter will be close to 2.0 percent, which ordinarily would be considered fine. However, with most areas of consumer spending showing little or no growth, the picture does not seem well-balanced. The sharp rise in spending on health care, which is the driving force in growth, is likely viewed by most consumers as a burden.

Investment growth is strong, but the future of the data center boom is questionable for a number of reasons. War-related spending is boosting growth, but that is not a healthy long-term path.