Inflation Heats Up, GDP Slows, and Consumers Feel the Strain

This week’s economic data includes: (1) PCE (Personal Consumption Expenditure) price index, personal income, and personal spending for December, (2) Q4 2025 GDP, and (3) weekly initial jobless and continuing claims.

KEY SUMMARY:

December data showed a pickup in inflation and resilient consumer spending, but with income gains driven largely by transfer payments rather than wages and the saving rate falling to a multi‑year low, underscoring growing financial strain on households and leaving them more vulnerable to a potential softening in the labor market or a financial market disruption.

Headline PCE inflation accelerated in December, rising 0.4% month over month and exceeding expectations, driven by higher prices across both goods and services. Goods inflation reflected strong gains in durable goods—particularly computer software and accessories—alongside modest increases in nondurable goods, while services inflation was broad‑based, led by sharp increases in video streaming and rental services, hotels and motels, road transportation, and housing‑related costs. Food and energy prices also rose during the month. On a year‑over‑year basis, headline PCE inflation increased to 2.9%, while core PCE inflation climbed to 3.0%, signaling persistent underlying inflation pressures, especially within services.

Personal income rose 0.3% in December, matching expectations but slowing from November, with a significant portion of the increase driven by transfer receipts such as government social benefits and settlement payments rather than wage growth. Year‑over‑year income growth eased to 4.3%, the slowest pace since mid‑2025. Disposable personal income also increased 0.3%, but after adjusting for inflation, real disposable income was flat. Meanwhile, personal savings declined, pushing the saving rate down to 3.6%, the lowest level in more than three years.

Consumer spending increased 0.4% in December, exceeding expectations and supported by continued strength in services, including recreation, housing and utilities, financial services, and holiday‑related travel, while goods spending declined modestly due to weaker durable goods purchases, particularly vehicles. On an inflation‑adjusted basis, real personal spending rose just 0.1%, slowing from November, and year‑over‑year growth decelerated. With real spending continuing to outpace real disposable income, the declining saving rate suggests consumers are becoming increasingly stretched and more vulnerable to potential labor market or financial market disruptions.

U.S. GDP growth slowed sharply to 1.4% in Q4 2025 due largely to a steep pullback in federal government spending and softer consumer demand, partially offset by resilient services consumption and strong AI‑driven private investment, leaving full‑year growth at 2.2% and setting expectations for a modest reacceleration in 2026.

U.S. real GDP grew 1.4% in Q4 2025, a sharp slowdown from 4.4% in Q3 and well below market expectations of 2.8%. The deceleration was driven primarily by a steep contraction in federal government spending related to the prolonged government shutdown, along with a moderation in consumer spending. These headwinds were partially offset by continued strength in private investment, particularly in AI‑related areas, while net exports made a small positive contribution to growth.

Consumer spending rose 2.4% in Q4, down from 3.5% in the prior quarter, reflecting slower but still resilient demand. Services remained the primary driver, led by strong gains in health care and other services such as international travel, while goods spending was mixed, with weakness in durable goods, especially motor vehicles, partially offset by modest growth in nondurable goods. Private investment rebounded 3.8%, supported by solid gains in nonresidential fixed investment, notably in information processing equipment and intellectual property products, while structures investment continued to decline despite accelerating data center construction; residential investment remained constrained by affordability challenges.

Government spending declined 5.1%, with federal outlays falling 16.6% and subtracting 1.15 percentage points from GDP, making it the largest drag on growth, while state and local spending increased modestly. Excluding the impact of the federal pullback, economic growth would have been much closer to expectations. Despite pressures from tariffs, supply chain disruptions, and the longest government shutdown on record, the economy expanded 2.2% in 2025, exceeding its long‑term trend, and markets expect growth to accelerate to 2.5% in 2026, supported by fiscal stimulus, continued AI‑driven investment, anticipated rate cuts, a stable labor market, and resilient consumer demand.

Weekly initial jobless claims fell well below expectations, signaling continued labor market stability, while a modest rise in continuing claims suggests unemployed workers are taking slightly longer to find new jobs.

Weekly initial jobless claims fell sharply to 206,000 for the week ending February 14, well below expectations and last year’s level, likely reflecting workers returning after weather‑related disruptions, while the four‑week average declined slightly, signaling continued labor market stability; however, continuing claims rose to 1.869 million—the highest since early January—suggesting that while layoffs remain low, unemployed workers are experiencing somewhat greater difficulty finding new jobs.

Equity markets ended the week modestly higher on the Supreme Court’s decision to strike down global tariffs, lifting trade‑sensitive and large‑cap tech stocks, while Treasury yields rose and rate‑cut expectations shifted later amid persistent inflation, resilient growth, and a reinforced higher‑for‑longer interest rate outlook.

Equity markets posted modest gains across major indices, supported by the Supreme Court’s 6–3 decision to strike down President Trump’s global tariffs. The ruling helped markets stabilize after midweek volatility driven by escalating U.S.–Iran tensions, weaker‑than‑expected GDP growth, and concerns that persistent inflation could keep interest rates higher for longer. Trade‑sensitive stocks, including Lululemon, Constellation Brands, Mattel, and Five Below, rallied on the news, while large‑cap technology names such as Nvidia, Amazon, and Apple also contributed to weekly gains. For the week, the Nasdaq rose 1.51%, the S&P 500 gained 1.07%, the Dow advanced 0.25%, and the Russell 2000 increased 0.65%, with small caps leading on a year‑to‑date basis.

Treasury yields moved higher across the curve, particularly at the intermediate and long end, reflecting hotter‑than‑expected PCE inflation, resilient Q4 economic growth despite the government shutdown, hawkish signals from the January FOMC minutes, and the Supreme Court tariff ruling. The 2‑year, 5‑year, and 10‑year yields rose to 3.48%, 3.65%, and 4.08%, respectively. Rate‑cut expectations shifted later, with markets now pricing the first cut in July 2026 instead of June, followed by another in October 2026, reinforcing a higher‑for‑longer outlook. Markets are also beginning to price an additional rate cut in late 2027, which would lower the federal funds rate upper bound to 3.25% if the anticipated 2026 cuts are implemented.

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DETAILED ANALYSIS:

PCE Price Index & Personal Income and Outlays – December Update: 

The Bureau of Economic Analysis (BEA) reported the latest statistics on the PCE price index, personal income, and personal spending:

PCE Price Index: In December, the headline Personal Consumption Expenditures (PCE) price index increased 0.4% month over month, exceeding market expectations of 0.3% and accelerating from November’s 0.2% gain. The increase reflected higher prices across both goods (+0.4%) and services (+0.3%). Within goods, durable goods prices rose 0.5%, led by a sharp increase in computer software and accessories (+7.0%), while nondurable goods prices increased 0.3%, driven primarily by stationery and miscellaneous printed materials (+2.0%). Beef prices rose 1.1% in December, extending a seven‑month streak of increases, while egg prices declined 7.5%, marking a fourth consecutive monthly decline.

Services inflation was driven by sizable increases in video streaming and rental services (+19.5%), hotels and motels (+2.6%), and road transportation (+2.3%). Housing-related prices also rose 0.3% in December, the fastest pace since August. Food and energy prices increased 0.4% and 0.2%, respectively.

On a year‑over‑year basis, headline PCE inflation rose to 2.9% in December from 2.8% in November, exceeding expectations and reflecting higher prices for both goods (+1.7%) and services (+3.4%). Over the same period, food prices increased 2.1%, while energy prices rose 2.2%.

Core PCE inflation – excluding food and energy and the Federal Reserve’s preferred inflation measure – also increased 0.4% month over month in December, accelerating from 0.2% in November and exceeding expectations of 0.3%. On a year‑over‑year basis, core PCE inflation rose to 3.0%, up from 2.8% in November and above market expectations of 2.9%, signaling continued underlying inflationary pressure.

Personal Income: Personal income increased 0.3% month over month in December, slowing from 0.4% in November (revised up from 0.3%) and matching market expectations. The gain was driven primarily by higher other current transfer receipts—reflecting settlement payments related to claims from the 2023 Maui wildfire—along with increased government social benefits, mainly Medicare, and modest growth in wages and salaries. On a year‑over‑year basis, personal income rose 4.3% in December, down slightly from 4.4% in November and marking the slowest pace since June 2025.

Disposable personal income—a key support for consumer spending—rose 0.3% in December, unchanged from the prior month. On a year‑over‑year basis, disposable income increased 3.8%, down slightly from 3.9% in November. However, real disposable income, adjusted for inflation, was flat, easing from a 0.1% gain in November. Year over year, real disposable income rose 0.9%, down from 1.0%, marking the lowest level since December 2022. Meanwhile, personal savings declined to $831 billion, pushing the personal saving rate down to 3.6%, the lowest level since October 2022 (3.4%).

Personal Spending: Personal spending, or consumer spending, rose 0.4% month-over-month in December, matching the revised November gain (down from 0.5%) and exceeding market expectations of a 0.3% increase. The advance was driven by a 0.7% rise in services spending, while goods spending declined 0.1%. Strength in services was led by recreation services (+2.5%), largely reflecting a sharp increase in video media rentals (+16.5%), housing and utilities (+0.8%), driven by higher electricity and gas costs (+4.5%), and financial services and insurance (+0.8%), supported by gains in portfolio management and investment advice (+3.1%). Reflecting the holiday travel season, spending on hotels and motels rose 2.1%. In contrast, goods spending weakened due to a 0.3% decline in durable goods, primarily stemming from a 1.6% drop in new motor vehicle purchases.

On an inflation-adjusted basis, real personal spending increased 0.1% in December, slowing from 0.2% in November (revised down from 0.3%) and in line with expectations. On a year-over-year basis, consumer spending rose 4.7% in December, decelerating from 5.3% in November.

Commentary: Personal income rose by $86.2 billion (0.3%) in December, in line with expectations but slower than the prior month. Notably, $38.4 billion of the increase (45%) came from personal current transfer receipts—primarily government social benefits and claim settlements—while only $24.3 billion (28%) was attributable to wages and salaries. Consumer spending exceeded expectations and remained resilient, led by strength in services. Monthly real disposable income was flat and down from November, while monthly real personal spending increased but also slowed relative to November. With real personal spending largely outpacing real disposable income since May, the saving rate has continued to decline to a three‑year low, signaling that consumers are becoming increasingly stretched financially and more vulnerable to adverse developments in labor and financial markets.

Q4 2025 GDP – Initial Release: 

According to the BEA initial estimate, U.S. real GDP grew 1.4% in Q4 2025, slowing sharply from 4.4% in Q3 and coming in well below market expectations of 2.8%. The deceleration was driven primarily by a steep decline in federal government spending related to the prolonged government shutdown and a moderation in consumer spending. These headwinds were partially offset by continued strength in AI‑driven private investment.

GDP Contribution Breakdown

• Consumer Spending: +1.58%
• Private Investment: +0.66%
• Net Exports: +0.08%
  • Decline in imports: +0.18%
  • Decline in exports: -0.10%
• Government Spending: -0.90%

Consumer Spending:

Consumer spending, which accounts for two-thirds of GDP, increased 2.4% (down from 3.5% in Q3). Growth slowed but remained resilient, driven primarily by services consumption, partially offset by weakness in goods.

• Goods:
  • Durable goods: -0.9%
    • Led by a 9.3% decline in motor vehicles & parts, subtracting 0.24% from GDP
  • Nondurable goods: +0.4%
    • Led by a 3.7% increase in clothing & footwear, contributing 0.07% to GDP
  • Services:
    • Health care: +5.6%
      • Contributed 0.63% to GDP, driven by outpatient, hospital, and nursing home services
    • Other services: +6.1%
      • Contributed 0.34% to GDP, led by increased international travel

Private Investment:

Private investment rebounded strongly, rising 3.8% in Q4 after flat growth in Q3.

• Fixed investment: +2.6% (up from 0.8% in Q3), contributing 0.66% to GDP
  • Nonresidential investment: +3.7% (down from +3.2% in Q3), contributing 0.51% to GDP
    • Equipment: +3.2% (down from 5.2% in Q3), primarily driven by:
      • Information processing equipment: +36.1% (up from 8.8% in Q3), contributing 0.65% to GDP
        • Led by computers & peripheral equipment (+80.1%), contributing 0.57% to GDP
      • Intellectual property products: +7.4% (up from 5.6% in Q3), primarily driven by:
        • Research and development (R&D): +9.4% (up from 8.4% in Q3), contributing 0.25% to GDP
      • Structures: -2.4%, declining for the 8th straight quarter, partially offset by accelerated data center investments (+17.9% vs +11.4% prior month)
    • Residential investment: +1.5%, declining for the 4^th straight quarter, primarily driven by affordability challenges
  • Inventories: Contributing 0.21% to GDP, led by wholesale trade and manufacturing)
    • This marked a rebound from inventory drags of -3.44% in Q2 and -0.12% in Q3, following significant stockpiling in Q1 (+2.58%) ahead of the April 2025 implementation of reciprocal tariffs

Government Spending:

Government spending declined 5.1% in Q4, down from +2.2% in Q3, primarily driven by federal government outlays:

• Federal: -16.6% (down from +2.7% in Q3), subtracting 1.15% from GDP, primarily led by:
  • National defense consumption: -13.5% (down from +6.6% in Q3)
  • Nondefense consumption expenditures: -30.8% (down from -2.1% in Q3)
• State & Local: +2.4% (up from +2.0% in Q3), driven by state & local gross investment (+6.7%)

Trade:

Net exports made a modest positive contribution of 0.08% to GDP:

• Exports: -0.9% following a 9.6% rebound in Q3, subtracting 0.10% from GDP
• Imports: -1.3%, contributing 0.18% to GDP

Final Sales to Private Domestic Purchasers:

This key measure of private demand, excluding inventories, trade, government spending and other volatile categories, rose 2.4%, down from 2.9% in Q3.

Commentary:

The sharp decline in federal government spending, which subtracted 1.15% from GDP growth, was the primary drag on Q4 economic performance. Excluding this impact, Q4 GDP growth would have been much closer to market expectations.

Despite headwinds from reciprocal tariffs, supply chain disruptions, and the longest government shutdown on record, the U.S. economy remained resilient in 2025, supported by steady consumer spending and sustained AI-driven investment. On an annual basis, real GDP expanded 2.2% in 2025, down slightly from 2.4% in 2024, but still above the long-term trend of approximately 1.8%.

Looking ahead, markets expect economic growth to accelerate to 2.5% in 2026, driven by fiscal stimulus (including tax refunds and business investment deductions), continued AI-related investment, anticipated interest rate cuts, a stable labor market, and resilient consumer demand.

Jobless Claims – Week Ending February 14:

The Labor Department reported that initial jobless claims fell by 23,000 to 206,000 for the week ending February 14, down from 229,000 the prior week (revised up from 227,000) and below market expectations of 225,000. The decline likely reflects workers returning to their jobs following temporary disruptions caused by heavy snow and freezing temperatures. Claims were also below the 224,000 level recorded in the same week last year. The four‑week moving average edged down to 219,000, from a revised 220,000 the prior week, suggesting continued stability in the labor market.

Continuing claims, which measure the number of individuals receiving unemployment benefits, rose by 17,000 to 1.869 million for the week ending February 7. This was slightly above market expectations of 1.860 million and marked the highest level since early January, though still below the 1.861 million recorded in the same week last year. The four‑week moving average of continuing claims increased marginally to 1.845 million from 1.844 million, indicating that unemployed workers are facing somewhat greater difficulty finding new jobs.

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MARKET ANALYSIS:

Equity Market Weekly Recap

Equity markets posted modest gains across the major indices, driven primarily by the Supreme Court’s 6–3 decision to strike down President Trump’s global tariffs. The ruling helped markets recover from midweek volatility caused by escalating tensions between the U.S. and Iran, weaker‑than‑expected GDP growth, and concerns that persistent inflation could keep interest rates higher for longer.

Trade‑sensitive stocks rallied following the decision, including Lululemon, Modelo and Corona importer Constellation Brands, toymaker Mattel, and discount retailer Five Below. Several large technology stocks, including Nvidia, Amazon, and Apple, also posted gains during the week.

On Feb. 21, 2026, President Trump announced plans to increase a global tariff to 15% from 10%, which was implemented Friday immediately after the Supreme Court decision. The tariff increase was enacted under Section 122 of the Trade Act of 1974, which allows for tariffs of up to 15% for a period of 150 days. The administration has also indicated plans to pursue more permanent levies later under Section 301 of the Trade Act. The 15% tariff would align these measures with the terms of major trade agreements previously completed with other nations, using the International Emergency Economic Powers Act (IEEPA).

Weekly and Year-To-Date (YTD) Performance Highlights:

• Nasdaq: +1.51% (weekly) & -1.53% (YTD), closing at 22,886
• S&P 500: +1.07% (weekly) & +0.93% (YTD), ending at 6,910
• Dow Jones Industrial Average (DJIA): +0.25% (weekly) & +3.25% (YTD), closing at 49,626
• Russell 2000: +0.65% (weekly) & +7.33% (YTD), ending at 2,664

Treasury Market Update

Treasury yields increased across all maturities this week, with the move more pronounced in the intermediate to long‑end of the curve. The rise in yields was driven by hotter‑than‑expected PCE inflation, resilient fourth‑quarter economic growth despite the prolonged government shutdown, hawkish signals from the January 27–28 FOMC meeting minutes, and the Supreme Court’s decision to strike down reciprocal tariffs.

Week‑over‑week changes in the Treasury yield curve were as follows:

• 2-year yield: 3.48% (+0.08%)
• 5-year yield: 3.65% (+0.04%)
• 10-year yield: 4.08% (+0.04%)

Rate Cut Expectations

Unlike last week, when markets were pricing in rate cuts in June and October 2026, expectations have shifted to July and October 2026, reinforcing a higher‑for‑longer interest‑rate outlook. Markets are also now projecting one additional rate cut toward the end of 2027. If the two cuts anticipated in 2026 are implemented, the federal funds rate’s upper bound would decline to 3.25%, from the current 3.75%.

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NEXT WEEK’S ECONOMIC CALENDAR:

Key scheduled releases include:

• 2/24 (Tuesday):
  • Conference Board Consumer Confidence (February)
• 2/26 (Thursday)
  • Weekly Initial and Continuing Jobless Claims
• 2/27 (Friday)
  • PPI (January)

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For a visual representation of this week’s economic review, you can view or download the slide deck here: 02.23.2026 CBC Weekly Economic Update Slides

Mark Yoon, CFA CPA

EVP & CFO of Commercial Bank of California

Thomas McCullough

EVP of Commercial Bank of California

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All content available on this material is general in nature, not directed or tailored to any particular person, and is for informational purposes only. Any of its content is not offered as investment advice and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. The information contained herein reflects the opinions and projections of Commercial Bank of California (CBC) as of the date hereof, which are subject to change without notice at any time. CBC does not represent that any opinion or projection will be realized. The information contained herein has been obtained from sources considered reliable, but neither CBC nor any of its advisors, officers, directors, or affiliates represents that the information presented on this material is accurate, current, or complete, and such information is subject to change without notice.