Viewpoints

State labor markets were again soft in December. No state had a statistically significant change in payroll employment; the largest absolute gain was a 19,700 increase in Texas, which was barely .1 percent.

Six states saw statistically significant increases in their unemployment rates (Delaware, Florida, Illinois, Minnesota, Oklahoma, and Washington)—Delaware’s was up .3 percentage points. The highest unemployment rates were in DC (6.7%), California (5.5%), New Jersey (5.4%), Delaware (5.2%), Nevada (5.2%), Oregon (5.2%), and Michigan (5.0%). Alabama, Hawaii, North Dakota, South Dakota, and Vermont had unemployment rates below 3.0%, with Hawaii and South Dakota’s the lowest, both at 2.2%.

Puerto Rico’s unemployment rate was again unchanged at 5.7% and the island’s job count rose by 3,600.

U.S. economic growth has remained solid through most of 2025, driven by healthy gains in consumption and strong business fixed investment, particularly for the buildout of AI. This has defied the pessimists’ worries about President Trump’s misguided tariffs, clampdown on immigration and cuts in research grants to universities. The only real laggard in 2025 was the housing sector, which suffered from continuous declines in construction and improvements. But that was last year and we should not expect any let up in erratic tariff policies and anti-immigrant initiatives in 2026.

Despite these obstacles, the outlook for sustained expansion in 2026 looks favorable, and the probability for recession is low. Current conditions are inconsistent with onsets of recession in the past. Consider the following two items that will support aggregate demand: 1) three Fed interest rate cuts in September-December 2025 lowered the real Fed funds rate below the Fed’s estimate of the longer-run real rate of interest consistent with its dual mandate of 2% inflation and maximum employment, and the Federal Reserve Bank of Chicago’s Financial Conditions Index signals loose financial conditions, and 2) fiscal policy is stimulative, as the OBBBA of 2025 extended the 2017 tax cuts and added some additional cuts (eliminating tax on income from tips, expensing of outlays for research and development) that will boost tax refunds in Spring 2026 by approximately 0.6% of disposable personal income. In this environment, 3) business inventories are relatively low and 4) employment is well-aligned with output (GDP). Accordingly, any slump in aggregate demand will not force businesses to cut output and/or employment in a meaningful way.

Labor market and personal income dynamics. One key trend to keep an eye on is real wage and salary incomes, a key indicator of labor market conditions and measure of consumer purchasing power. Growth in personal income from wages and salaries has decelerated to 3.8% in the year ending November 2025 (Chart 1). That’s down from a 5.5% rise in the prior year. At the same time, CPI inflation was 2.7% in the last two years ending November 2025. According, the year-over-year growth in real personal disposable income from wage and salaries has receded to 1.1% in the year ending November 2025, significantly slower than its 2.8% rise in the prior year.

This deceleration in real wages and salaries reflects primarily a combination of moderating gains in average hourly earnings (AHE) and weakness in employment. As shown in Chart 2, AHE have moderated to 3.5% year-over-year growth from 4.1% a year earlier. The yr/yr rise in AHE will decline further in the January and February 2026 readings as the high monthly increases in Jan-Feb 2025 roll off. At the same time, establishment payroll gains have flattened significantly. In the six months July-December 2025, employment rose a net 87,000, an average of 14k per month; in the prior six months jobs rose 497k, an average monthly rise of 82k (Chart 3). In the prior year ending December 2024, employment rose over 2 million.

State real GDP growth rates in 2025:3 ranged from 0.4% in North Dakota to 6.5% in Kansas. North Dakota’s performance was a major outlier (Minnesota was the next weakest state, with a 2.7% real growth rate) and appears largely attributable to a major, but localized, contraction in agricultural output. The vast majority of states had growth rates above 3.3% (in Massachusetts). Among larger states, Pennsylvania and North Carolina stood out with 5.6% growth rates (Michigan and Ohio were also above 5%0, while Florida’s rate was 3.5%. Manufacturing and finance were major contributors to growth, and states in the Midwest, as well as New York, benefitted from those.

Personal income growth rates ranged from 6.3% in Kansas to 0.1% in Louisiana. The weakness in Louisiana was due to an aberrant sharp contraction in transfer payments following very strong growth in the second quarter. On the flip side, gains in transfers played an outside role in New York’s 4.2% . Earnings growth was unusually high in Iowa and South Dakota; unusually low in Oklahoma.

The GDPNow model has several shortcomings, and here's an example. After the Census Bureau released October's construction spending data, the GDPNow model increased its Q4 GDP estimate to 5.4%, up from the previous 5.3%. However, a closer look at the detailed construction data suggests that the Q4 GDP estimate should have been revised downward, not upward. The GDPNow estimate for Q4 residential investment was adjusted from -5.7% to -1.0%. Yet, October's construction data indicates spending declines in new single and multi-family construction, alongside an increase in reported spending on remodeling and improvements. The latter relies on a survey that the BEA does not incorporate into its GDP calculations. Instead, the BEA uses retail spending data from building materials and hardware stores to estimate home modeling. In October, consumer spending in that retail category decreased by 1.3%.

In summary, GDPnow estimates have several shortcomings and should not be considered a definitive measure of economic activity.

Because the federal government was shut down in October the Bureau of Labor Statistics (BLS) did not conduct a survey of consumer prices that month but then reported two-month changes (for September-November) in prices with the following release of the Consumer Price Index (CPI). At the time I, in a commentary here (“A Dodgy CPI Rent Reading for November,” December 20, 2025), and others viewed the reported sharp two-month deceleration in the shelter component of the CPI with suspicion. Subsequent methodological clarifications from the BLS confirmed those concerns.

In October, for price levels not surveyed, the BLS assumed (unreported) changes of zero from September to October. In principle, with price levels then correctly measured in November, the two-month changes reported for September-November are correct. It is as if (implied) price increases in November include catch up effects, but with one important exception: rent.

The BLS stratifies its full panel of housing units into six subpanels that are surveyed in rotation. Each month the BLS assumes the monthly change in the shelter component of the CPI equals the sixth root of the six-month change in rent reported for the currently surveyed subpanel. Since a survey was not conducted during the shutdown, the BLS assumed that the rent for the subpanel that would have been surveyed in October was the same as in April when that subpanel was last surveyed. Because in October the six-month change in rent was thus assumed to be zero so, also, was the one-month change (i.e., the sixth root of zero).

The Federal Reserve Bank of Philadelphia’s state coincident indexes in November continued to be generally soft. In the one-month changes, Hawaii, Missouri, and Nevada had increases above .50 percent, but 12 were down, with West Virginia off by more than one percent. Over the three months ending in November, four states (Hawaii, Missouri, Iowa, and Alabama) had increases of 1.00 percent or more, while eight fell, with Montana and West Virginia seeing declines of more than one percent. Over the last twelve months, three states were down (Delaware by nearly 1 ½ percent), and seven others saw increases of less than one percent. Nine states saw increases of 3 percent or more, with Alabama’s 3.89 percent at the top.

The independently estimated national estimates of growth over the last three and twelve months were, respectively, .44 and 2.15 percent. The three=month reading seems to be in line with what the state numbers would have suggested, while the twelve-month one appears to be a bit lower.

Due to the absence of state unemployment rates for October, the indexes were computed using a modified method.

US voters have not waited for midterm elections—or even a full year—to register their dissatisfaction with Donald Trump’s turbulent return to office. In November last year, Democrats swept key state races in New York, Virginia, and New Jersey. The message from voters was unmistakable: rising living costs and the impact of higher import tariffs are biting hard.

The affordability crisis is already reshaping America’s political landscape. The Financial Times examined the soaring cost of living in New York and the unexpected election of Zohran Mamdani, the 34-year-old Democrat to the office of the mayor. The numbers tell a stark story. Average childcare costs approach US$1,450 per month, yet only 14.5% of New York families can afford them. More than half of renter households spend at least 30% of their income on rent, and between 60,000 and 80,000 New Yorkers sleep in shelters every night.

And New York is far from an outlier.

Recently, a close friend visited us from Boston, and conversation inevitably turned to expenses. Even mundane purchases now come with sticker shock. A simple lunch—sandwiches for two—costs US$30 to US$35. When her German Shepherd needed an X-ray, the bill came to US$1,300; a CT scan was offered for US$3,000. Removing 11 trees from her garden cost US$9,000. She and her husband work in finance and are relatively affluent, so these examples are anecdotal—but they vividly illustrate how sharply costs have risen across the US.

When she insisted on picking up the lunch tab during her visit to the UK, we did not feel too guilty. At £54 with wine (US$71), it was a bargain, even after accounting for the US dollar’s depreciation against sterling.

Both the Financial Times article and these conversations raise important questions. How widespread is the cost-of-living squeeze? How much pressure is Trump under to deliver on his MAGA agenda? And how constrained is the Federal Reserve as it balances rising inflation against already-stretched households?

Income and Spending: A Divided Country

In 2024, the average American took home US$64,426 after taxes, according to data from the Bureau of Economic Analysis (Figure 1). Per capita disposable income exceeded that level in just 18 states. The District of Columbia topped the list at US$92,365, followed by Connecticut at US$80,694. In contrast, residents in 33 states earned less than the national average. Mississippi ranked last at US$47,831, with West Virginia close behind at US$50,444.

If you rely on the GDP estimates from the Federal Reserve Bank of Atlanta's team, the US economy is performing the improbable by growing well beyond its potential, despite two key sectors experiencing no growth and minimal new job creation. The Atlanta Fed's GDPnow estimate suggests that Q4 GDP growth is at an annualized rate of 5.1%. However, that estimate of output growth is at odds with the weak growth picture depicted by data from manufacturing, housing, and employment. That data indicates that GDP growth is occurring at, at best, half the rate.

The US economy is composed of three primary sectors: goods, structures, and services. The Federal Reserve's industrial production metric shows that manufacturing output in Q4 through November is lower than in Q3, suggesting minimal, if any, growth in goods output for Q4.

The structures component includes three sectors: housing, nonresidential, and state and local. Housing starts in October are significantly below the Q3 average, indicating a decrease in residential construction activity. Nonresidential construction has been weak throughout 2025, with data indicating a decline in Q4. Meanwhile, state and local construction spending shows minimal growth. Thus, the structures component is likely to weigh on Q4 GDP.

This leaves the service sector, the largest of the three. The service sector doesn't seem to be expanding rapidly enough to support the GDPNow estimate either. For instance, private sector service job growth amounted to just 112,000 in the three months ending in December.

Moreover, for the GDP output to increase by more than 5%, the income side must show a similar rise. However, the data on jobs, wages, and hours indicate a very modest increase in labor income in Q4. To align with the GDP output growth estimate, there would need to be an extraordinary increase in operating profits to offset the weak labor income. Companies would have to register a record increase in margins to do that, which is unlikely given the price data.

The government shutdown, which lasted over 40 days, affected and delayed several economic reports to such an extent that it's currently very challenging to obtain a reliable assessment of the Q4 economic performance. Nevertheless, if the data on jobs, manufacturing, and housing accurately represent the situation, then GDPnow is more than 50% off.