Markets, the Fed, and a consumer that refused to quit—2025 rewrote the rulebook.
KEY TAKEAWAYS
2025 delivered stronger economic and market outcomes than expected
The economy grew despite restrictive monetary policy
Consumers continued to support growth
Markets struggled with strong data due to rate cut expectations
AI-driven productivity is reshaping growth dynamics
MY HOT TAKES
This is not a normal cycle–it’s a transition
Markets are addicted to stimulus and uncomfortable without it
Productivity gains are being underestimated
The Fed risks focusing too narrowly on backward-looking data
2026 expectations will hinge more on leadership than data prints–though there will be plenty of those
You can quote me: "You're not supposed to have strong growth, cooling inflation, and restrictive rates–and yet we just did.”
My slice of the cake. We are getting close folks! Really close. Another day or so depending on where you read this note, and we sail off into 2026. This has been quite a year, 2025. By this time of year, I am usually well past the “what happened this year stage,” but the fact of the matter is that SO MUCH happened this year, and so much is still happening, I think it best to wait for this upcoming weekend to really have a close look at my pile of lab notebooks and steno pads and recount the year’s highlights. I know that doesn’t seem very official as the weekend will already technically be 2026, but I don’t want to miss anything. I speak a lot with journalists who are on the ground everyday, for every news cycle, and they all seem to agree that this has been one heck of an exciting year. I am not going to even attempt to start to recap the year, but I will tell you that, overall–and I think most of my colleagues would agree (maybe not on record)--that ‘25 turned out far better than expected from an economic and market perspective.
Last January 1st, we were getting ready to welcome President Trump back into the White House, which based on the 2024 performance and his business-friendly approach, was injecting lots of positive investor sentiment into the markets. Sentiment is one thing, but the fundamentals needed to support it is quite another. Would the economy cooperate? That was a big wildcard. The early estimates for GDP in 2025 were good but not great. Inflation was still a challenge and the Fed, despite late ‘24 cuts was clearly going to play it cool while it got the lay of the land under Trump 2.0. Playing it cool meant no rate cuts, which meant keeping the brakes engaged. Rates were and are still–for the most part–restrictive. Well, they are certainly not stimulative. We didn’t have the full year’s GDP numbers yet, but it was clear that the economy, though healthy, was losing steam into the end of the year. Ultimately, we still ended up with a respectable 2.8% growth for the year, slightly below 2023’s 2.9% print. Early 2025 estimates were for a continued, modest deceleration for the year. Of course, there were a few moving variables: namely the President’s fiscal policy and the Fed’s monetary policy.
As the calendar year turned, it became immediately clear that the two would not be working in sync with each other. This should be no surprise. Stimulative fiscal policy is inflationary. If you throw in tariffs–also considered to be inflationary–the Fed’s hands would be tied. In other words, the buffet was about to close. This tension between Fed policy and economic performance would really highlight the entire year. It played out in the boring numbers on Wall Street traders’ screens. It played out in the press with wildly concocted headlines. It played out… everywhere with the President’s public–very public–jawboning the Fed and Chairman Powell. To be clear, Wall Street's hunger for stimulus is an age-old thing; stock markets are junkies for stimulus. Why not? More is good, right? That was not a real question, so don’t bother answering.
In any case we ended up right here, right now after a long twisted path that saw economists raise their probabilities for a recession up from 20% to as high as 40% by late spring (check out the chart above). Simultaneously, those same economists were raising their GDP estimates for the year. 🤲 This makes very little sense, wouldn’t you say? Last week, the Bureau of Economic Analysis (BEA) gave us a first look of Q3 GDP (it was late because of the shut down), and it came in beating estimates wildly with a 4.3% print. Now, granted, it was Q3, but it still made quite a statement: “the consumer continues to carry this market.” This all despite declining confidence and a weakening labor market. Let’s be really clear on this, that is good news for the economy. Markets traded higher on the news, but not quite what one might have expected. Why? Because a stronger economy gives the Fed more of a reason to take its time on any future rate cuts. This is the old “good is bad.” In some sick sort of way, markets would have rallied more if the number came in shy of estimates because of its unrelenting lust for rate cuts.
The President certainly did not miss the economic release, and he took to his Truth Social Platform to pen “THE TRUMP RULE” (pictured below). He lamented that good news should make markets go up, not down. He argues modern markets perversely sell off on good news because Wall Street fears the Fed will hike rates, whereas in the “old days” markets knew better. Strong markets, he insists, don’t cause inflation–bad thinking does–and rate hikes are only appropriate after massive rallies, not during success. He closes by demanding a compliant Fed chair, promising historically great numbers, and warning that anyone who disagrees is definitely not getting the job. Well, I am inclined to agree with the basic premise that markets should rise on the strong economic news, though I am not looking for the job. I also believe that the Fed is risking a labor market disaster by attempting to fine-adjust rates. I am not looking to get the job, really.
And yet, here we are. Sitting in a place that conventional wisdom insists should not exist. An economy growing well above trend, inflation not reigniting in any meaningful way, financial conditions tighter than anyone would like, and still no recession. Every Econ 101 textbook on the shelf is tapping us on the shoulder saying, “this isn’t how it works.” You can’t have your cake and eat it too. You can’t have a hot economy without inflation. You can’t have solid growth with restrictive rates. You can’t have all three. And yet, for much of this year, we kind of did. 🫤
That does not mean gravity has been repealed. It does mean that this is not a conventional economy. It is an economy in transition. We are at the early stages of a productivity story that is very real and very powerful. Artificial intelligence is not a buzzword anymore; it is showing up in earnings calls, capital budgets, and workflow decisions across industries. Productivity gains are slow to show up in the data, and when they do, they tend to sneak in quietly before economists argue about them loudly. Over the next decade, AI-driven productivity has the potential to expand output without putting the same pressure on prices that old-school growth cycles did. More output per worker changes the math. It doesn’t eliminate inflation risk, but it can dull the edge.
That is why it is at least plausible that we live in a world where growth remains solid while inflation gradually cools, not collapses, not disappears, but drifts lower over time. That would be deeply uncomfortable for anyone anchored to historical playbooks, including the Fed. Monetary policy works with blunt tools, long lags, and imperfect information. Fine-tuning an economy like this is hard on a good day. Doing it while fiscal policy is stimulative, tariffs loom in the background, and productivity is shifting underneath your feet is harder yet.
This is where 2026 starts to matter. Not because January magically changes anything, but because leadership changes shape expectations. The President will soon have the opportunity to pick his next Fed Chair, and markets are already gaming out what that means. Will growth be tolerated longer? Will labor market softness carry more weight than backward-looking inflation prints? Will productivity gains earn more patience? These questions will not be answered in press conferences. They will be answered slowly, quarter by quarter, decision by decision.
As for growth, expectations are settling into a familiar range. GDP is projected to come in similar to, or slightly slower than, this year. In other words, not a boom, not a bust, but a continuation of where we started 2025 before everyone revised everything five times. And there will be revisions. Lots of them. The next few quarters are likely to see data rewritten as inventories, trade, and consumption get rebalanced after a chaotic year. That does not mean the numbers are fake. It means measurement is messy during transitions.
Which brings us back to the beginning. My slice of the cake. We are all staring at an economy that refuses to behave, insisting on growing when it shouldn’t, cooling when it supposedly can’t, and surviving conditions that were meant to break it. Maybe the old rule still applies and the bill eventually comes due. Or maybe this cake recipe has changed just enough that you can actually enjoy a slice without the whole thing collapsing. We got our cake, and for now, we are eating it–carefully. Let’s enjoy it… at least until next Monday morning when we step on the scale.
YESTERDAY’S MARKETS
Stocks slipped yesterday with no real catalysts to carry it over the finish line of 2025, which approaches fast. Santa’s sleigh is still on the outer rings of the radar at NORAD–the Santa Rally which technically lasts through the first week of the year can still happen. Don’t lose ho-ho-hope.
NEXT UP
FHFA House Price Index (October) is expected to have gained by 0.1% after coming in flat a month earlier.
MNI Chicago (December) may have gained to 40.0 from 36.3.
The Fed will release its minutes from its December 10th FOMC meeting. Many expect it to be a hawk-fest. The big question is whether the market will view that as old news and end the year feeling positive about strong economic numbers. Hard to tell, so better plan on checking out the minutes at 2:00 PM Wall Street Time.
We will be back on Friday with both feet firmly planted on the ground in 2026.