The double-whammy that's about to hit the US economy

If you ask most economists, market experts, and even the Federal Reserve, the story of the US economy for the rest of 2026 will be one of strong and steady growth. But there are serious reasons to doubt this forecast of calm waters.

There's no better example of the sanguine consensus view than the Fed's latest Summary of Economic Projections, released as part of the central bank's meeting on Wednesday. According to the FOMC's rundown, no participants saw the risks to GDP growth as tilted to the downside. Meanwhile, after this week's interest rate hike — the first in three years — investors and analysts don't really see the Fed taking much more action. In the face of buoyant growth predictions and strong financial conditions, the market is priced for another two rate hikes between now and March, not much else. Again, this feels optimistic given the near-term risks that inflation could reheat in the coming months.

Despite the rhetoric, the US economy is facing a squeeze from two ends. The first is a slowdown in consumer spending , as Americans pull back amid higher inflation , sluggish income growth, and geopolitical uncertainty . The second is the Federal Reserve's renewed interest rate hikes , which will ultimately need to slow the economy down to tame price hikes. Hoping for inflation to cool on its own seems more difficult to justify every month that inflation remains above the Fed's target.

There are reasons to expect consumer spending to slow and reasons to expect the Fed not to act as a shock absorber. The net effect of this is clear: somewhat higher unemployment and somewhat tighter financial market conditions (aka lower stock prices), in order to ultimately achieve slower inflation.

In recent years, American consumers have been the crucial drivers of the economy. While AI has attracted considerable attention , consumer resilience has been an important driver of US GDP . In the first half of 2026, Americans did their part and used their wallets to fuel the economy. Indeed, in the second quarter of the year, real consumption added nearly 2.5 percentage points to growth. Growth in the current quarter continues to run at a breakneck pace, but looking at the rest of the year, there are several reasons to worry that spending may not hold up.

The most obvious reason for the slowdown is that the boost from larger tax refunds is fading away. In the first half of the year, Americans saw about an 11% increase in their average refund compared with last year, thanks to changes made by last year's Big Beautiful Bill tax reform law. The boost in income from lower taxes has contributed 0.4 percentage points to US GDP so far in 2026, according to Brookings' Fiscal Impact Measure. Despite this tailwind, inflation-adjusted consumer spending grew at only a 2.0% annual pace over the first half of the year, similar to its 2025 rate. In the second half of this year, the contribution of taxes and benefits to US GDP is projected to slow to zero, then become a drag on the economy in 2027 — in other words, fiscal policy is transitioning from tailwind to headwind.