ECONOMIC CONDITIONS

Moderate growth expected in 2026

Real gross domestic product (GDP) grew at an annual rate of 0.7% in the fourth quarter of 2025, according to the U.S. Bureau of Economic Analysis’ (BEA) second estimate, published March 13. (See Figure 1.) This is a significant slowdown from the second and third quarters, in which the economy grew by 3.8% and 4.4%, respectively. At least some of this slowing growth can be attributed to the record-long government shutdown that ended on Nov. 12, 2025.

The rate at which real gross domestic product (GDP) grew in the fourth quarter of 2025.

“Compared to the third quarter, the deceleration in real GDP in the fourth quarter reflected downturns in government spending and exports and a deceleration in consumer spending that were partly offset by an acceleration in investment,” the BEA said. “The decrease in imports was smaller than in the previous quarter.”

The BEA reported that real GDP increased 2.1% in 2025, down from 2.8% growth in 2024.

What’s shaping the U.S. economy

3 tailwinds are driving U.S. GDP:

Massive investments in AI.

While data centers have received much public attention, AI investments are also reflected in specific expenditures in information processing equipment, software, and research and development. Collectively, these investments “helped prevent a sharper contraction in the first quarter and accounted for 30% of GDP growth in the second quarter and 11% of GDP growth in the third quarter,” the Federal Reserve Bank of St. Louis said in a recent analysis of BEA data. For now, AI stands as a powerful growth engine. It is unclear, however, whether it will prove to be a perpetual boom, an unavoidable bubble that eventually bursts, or something in the middle.

Healthcare spending.

This has become a key force of economic growth, especially as the U.S. population ages. National health expenditures accounted for 18.0% of U.S. GDP in 2024, according to the Centers for Medicare and Medicaid Services, and are projected to account for one-fifth of U.S. GDP in 2032. (See Figure 2.) National health expenditures include spending by patients, healthcare systems, the federal government, and individual states.

Consumer spending.

This remains the primary engine of the economy, accounting for roughly 70% of total GDP. In the fourth quarter, personal consumption expenditures grew by 2.0% from the third quarter, despite consumer confidence remaining weak. Preliminary March data shows that the University of Michigan’s Index of Consumer Sentiment fell 1.1 points from February. (See Figure 3.) March data is based on interviews collected between Feb. 17 and March 9, roughly half of which were completed before the start of the recent military conflict in the Middle East, the university said.

The American consumer’s resilience partially reflects balance sheet strength. Household net worth has increased by more than $65 trillion since the start of 2020, according to the Federal Reserve, supported in large part by equity market appreciation. A strong stock market has bolstered retirement accounts, brokerage balances, and overall financial confidence, particularly among higher-income households that own a disproportionate share of financial assets.

This dynamic reinforces the so-called "K-shaped" nature of the current economy. Asset-owning households continue to benefit from rising equity values and stable employment, which is sustaining discretionary spending. Meanwhile, lower-income and more rate-sensitive consumers struggle with inflationary pricing and tighter budgets. The result is a consumer sector that remains resilient in aggregate, even as underlying conditions diverge beneath the surface.

What the Middle East conflict could mean for the economy

After weeks of military buildup, the U.S. and Israel launched widespread military strikes against Iran on Feb. 28. Iran’s Supreme Leader Ayatollah Ali Khamenei, along with several other top Iranian officials, were killed within the first 24 hours of the conflict.

The fighting continued into March with U.S. and Israeli forces carrying out an intense bombing campaign against Tehran and other key Iranian cities. Iran has responded with its own strikes on critical energy infrastructure — including pipelines, terminals, and refineries — as well as population centers, military sites, and intelligence centers in the surrounding Persian Gulf countries.

It’s uncertain how long hostilities will continue, but a prolonged conflict could have significant economic implications. Consumers would spend more at the gas pump and curtail their spending elsewhere. Leisure and business travel would slow. Raw materials and commodity prices would also increase as shipping costs and inputs rise. Accelerating inflation would complicate the Fed’s decision-making on interest rates, particularly given the softening labor market.

While investors initially appeared to shrug off the risks to equity valuations posed by the conflict, recent activity reflects growing investor concerns about its duration and uncertainty around the conflict's outcome. A prolonged conflict, which could bring higher energy prices, could further erode investor confidence. Since mid-March, Brent crude oil futures have frequently traded at over $100 per barrel on the ICE Futures Europe market, closing at a recent high of $112.19 on March 20.

Inflation eases, labor market weakens

After remaining at 2.7% or higher for the previous seven months, “headline” inflation — the topline Consumer Price Index (CPI) figure reported monthly by the U.S. Bureau of Labor Statistics (BLS) — slowed to 2.4% year over year in January and remained unchanged in February.* (See Figure 4.) Core inflation — which excludes volatile food and energy costs — was also unchanged in February after slowing slightly in January to 2.5% year over year, its lowest level since March 2021.

It is important to note that inflation measures the pace of change, not the direction. While the rate of inflation is moderating, the cumulative price increases of the past several years have not reversed. Consumers are still contending with high costs for housing, insurance, services, and everyday essentials.

This distinction explains the continuing disconnect between improving inflation data and weak consumer sentiment. Consumers appreciate the slower rate of increase, but prices are still significantly higher than before the COVID-19 pandemic. For businesses, margin pressure has eased at the edges, but input and labor costs remain high.

Employers added 126,000 jobs but lost 92,000 jobs in February, according to BLS data. (See Figure 5.) The unemployment rate edged up in February to 4.4%.

While the January jobs gains were a positive, the February losses and slight increase in the unemployment rate are troubling. A more important development is that earlier 2025 figures have been revised downward significantly: Jobs gains during the year were off by more than 400,000 compared with initial reports. This indicates that hiring momentum has been weaker than previously estimated and reflects the challenges associated with estimating overall labor strength in a shifting economy.

When viewed alongside moderating inflation, the revised figures point to an economy that is cooling but not contracting. Growth continues, though with less underlying acceleration than previously suggested. A "soft landing" for inflation remains plausible, but the margin for error is narrower than it may have seemed just a few months ago. The Organisation for Economic Co-operation and Development forecast on March 26 that inflation for the G20 will be 4.0% in 2026, “reflecting the surge in global energy prices.”

Further complicating the economic outlook is a lack of clarity about the U.S. government’s long-term tariff policy. On Feb. 20, the Supreme Court, in Learning Resources Inc. v. Trump, held that the International Emergency Economic Powers Act does not authorize the president to unilaterally impose tariffs. The ruling effectively invalidated the majority of levies President Trump has imposed since returning to office and clarified limits around executive trade authority.

Despite this, tariff uncertainty persists. The White House has already indicated it will rely on other statutory mechanisms to reinstate certain duties. The legal rationale has changed, but not the policy.

The ruling has also triggered a wave of litigation. Hundreds of companies have filed suit seeking repayment of previously collected tariffs, with billions of dollars potentially at stake and more claims likely to follow. The Supreme Court left the question untouched, and it is unclear how this may play out.

The bottom line: Trade policy remains fluid, and in the near term, businesses should anticipate continued volatility rather than resolution.

Mixed signals from businesses

CEO confidence among large firms improved meaningfully in the first quarter of 2026. The Conference Board Measure of CEO Confidence rose from 48 in the fourth quarter of 2025 to 59 in the first quarter of 2026, its highest reading since the first quarter of 2025. (See Figure 6.) Importantly, The Conference Board's survey was completed in early to mid-February, before the recent Middle East conflict.

Views of current conditions turned moderately positive, and six-month expectations shifted from slight pessimism late last year to moderate optimism. This trend likely reflects improving visibility, moderating inflation, stable capital markets, and stronger balance sheets.

In contrast, the National Federation of Independent Business (NFIB) Small Business Optimism Index slipped slightly to 98.8 in February, down from 99.3 in January. (See Figure 7.) While the decline was modest, it underscores that small businesses remain more cautious than larger companies. Small businesses are more exposed to interest rates, labor costs, and demand variability. They also have less pricing power and fewer options to buffer policy and trade volatility.

All eyes on the Fed

At its March 17-18 meeting, the Fed elected to leave interest rates unchanged, keeping the federal funds target range at 3.5% to 3.75%. After cutting rates in each of its final three meetings of 2025, March was the second consecutive meeting in which the Fed opted not to change rates.

The pause on rate cuts in January and March signals a transition from active easing to a more data-driven approach. That said, 12 of 19 members of the Federal Open Market Committee (FOMC) indicated their view that the Fed should cut rates at least once in 2026, which is consistent with market sentiment.

“Available indicators suggest that economic activity has been expanding at a solid pace," the FOMC said in a statement following its March meeting. “Job gains have remained low, and the unemployment rate has been little changed in recent months. Inflation remains somewhat elevated.

“Uncertainty about the economic outlook remains elevated. The implications of developments in the Middle East for the U.S. economy are uncertain. The Committee is attentive to the risks to both sides of its dual mandate.”

For the Fed, the path forward is unclear. The central bank must walk a tightrope between doing too much and too little, and officials are mindful that changes can sometimes take months to show results.

Monetary policy is also increasingly becoming intertwined with politics. Chair Jerome Powell’s term ends in May; in January, President Trump nominated Kevin Warsh to succeed him. If confirmed, Warsh is expected to align more closely with the administration’s preference for lower rates. Warsh is also a vocal advocate for shrinking the Fed’s balance sheet, arguing that excess liquidity can distort asset prices. That could signal tighter financial conditions, adding further uncertainty and confusion.

The transition places the Fed in an awkward position. What has traditionally been seen as an apolitical, technical, and data-driven institution now risks being embroiled in larger political battles. This could introduce the perception of partisanship, regardless of how well grounded policymaking remains.

For insurance buyers and insurers, the implications of all this are twofold: First, policy direction remains highly uncertain. Second, the Fed itself may become a source of volatility amid political division.

Looking ahead

Most economic prognosticators anticipate continued but moderate U.S. growth. The International Monetary Fund (IMF) projects growth of 2.4% in 2026 and 2.0% in 2027. (See Figure 8.) That pace exceeds expectations for much of Europe and several other advanced economies, reflecting the relative strength of U.S. consumer spending, capital markets, and technology-driven investments.

At the same time, overall global growth is expected to outpace the U.S., fueled by faster expansion in emerging markets. The IMF outlook reflects an economy that is slowing from its post-pandemic momentum but not stalling.

For insurance buyers and carriers, these projections suggest a stable operating environment with slower premium growth across many lines. Economic activity will continue but at a more moderate pace, with payrolls, sales, and property values remaining relatively stable. Capital investment in technology and AI will continue and help offset weaknesses elsewhere in the economy. Consumer spending and fiscal policy are also expected to remain supportive.

Inflation remains a wild card as underlying costs for materials, labor, and repairs remain elevated. Similarly, tariffs and turmoil in the Middle East may disrupt supply chains while midterm elections further cloud the outlook.

As the economy settles into a slower, more normal growth phase, discipline with regard to underwriting, pricing, and capital allocation is likely to continue.

*The BLS did not publish October 2025 inflation and unemployment rate data due to the lapse in government appropriations.