The Impact of Strong U.S. GDP Growth on Treasury Yields and the Outlook for 2026 Rate Cuts

The U.S. economy's unexpected resilience in Q3 2025 has sent ripples through financial markets, challenging assumptions about inflation, monetary policy, and the trajectory of Treasury yields. With real GDP expanding at a 4.3% annualized rate-well above the 3.2% forecast-investors are recalibrating their expectations for 2026 rate cuts. This analysis examines how the interplay of robust growth, inflationary pressures, and Federal Reserve (Fed) policy signals shapes the viability of rate cut bets in a resilient economy.

Strong GDP Growth and Its Inflationary Implications

The Q3 2025 GDP report revealed a surge in consumer spending (up 3.5%), bolstered by a smaller trade deficit and increased business investment in AI, despite headwinds like higher tariffs and a government shutdown according to CNBC. However, this growth came with a cost: the GDP deflator rose 3.8% year-over-year, signaling persistent inflationary pressures. Core PCE inflation hit 2.9% in Q3, overshooting the central bank's 2% target.

These developments immediately impacted Treasury yields. The 10-year note yield climbed to 4.19% from 4.15% as markets priced in heightened inflation risks and the Fed's recent 25-basis-point rate cut in December 2025. The correlation between GDP growth and yields underscores a critical tension: while strong economic performance typically supports lower yields, the Fed's dual mandate of price stability and maximum employment forces a recalibration of expectations.

Fed's Cautious Path Toward Rate Cuts

The December 2025 Summary of Economic Projections offers a nuanced view of the Fed's strategy. Policymakers now project 2.3% real GDP growth for 2026, up from 1.8% in September, reflecting confidence in AI-driven productivity and consumer resilience. However, inflation remains a sticking point. The Fed anticipates core PCE inflation to ease to 2.5% in 2026 but acknowledges it will stay above 2% until 2028. This timeline suggests a prolonged period of accommodative policy, with the Fed's dot plot indicating one or two rate cuts in 2026, likely after a pause in early 2026 and the confirmation of a new Fed Chair in May.

Traders, meanwhile, remain skeptical. Despite the Fed's cautious stance, market pricing still anticipates two 25-basis-point cuts in 2026. This divergence highlights the uncertainty surrounding inflation's trajectory and the potential for external shocks, such as the pass-through effects of tariffs or a slowdown in AI investment. Goldman Sachs and Morningstar, for instance, forecast two and three cuts, respectively, by year-end 2026 according to the Federal Reserve.

Assessing the Viability of Rate Cut Bets

The viability of rate cut bets hinges on three factors: the pace of inflation moderation, the durability of GDP growth, and the Fed's response to labor market dynamics. While the Fed's December rate cut signaled a shift toward easing, its projections suggest a measured approach. The unemployment rate, expected to remain at 4.5% in 2025 and 4.4% in 2026, indicates a tight labor market that could delay aggressive rate cuts.