Markets Cheer Tariff Win—But Weak GDP and Sticky Inflation Could Spoil the Party

Markets initially cheered the Supreme Court’s decision striking down the IEEPA tariffs, sending equities higher on hopes that a significant trade overhang may soon be lifted. The ruling helped push rate-cut expectations further out, with futures now centering more squarely on July and even October for the next potential move. But once the initial pop fades, investors will need to grapple with a more complicated reality: today’s economic data painted a picture of slower growth and stubborn inflation — not exactly the backdrop for a clean, policy-driven rally.

The advance estimate of fourth-quarter GDP showed the U.S. economy expanding at just a 1.4% annualized pace, well below expectations near 3% and sharply down from 4.4% in Q3. Final sales rose just 1.2%, also missing estimates. On the surface, it was a clear disappointment. However, context matters. A large portion of the weakness stemmed from the record-length government shutdown, which the Commerce Department estimated shaved roughly one percentage point off growth. Federal government spending plunged 16.6% in the quarter, contributing to a broader 5.1% drop in overall government outlays.

Strip out some of that noise, and the picture looks somewhat firmer. Final sales to private domestic purchasers rose 2.4%, and gross private domestic investment climbed 3.8% after being flat in Q3. Consumer spending still increased 2.4%, albeit down from 3.5% previously, while exports retrenched after a strong prior quarter. Several economists argue the shutdown distortion makes Q4 feel dated and potentially understates early-2026 momentum. That said, growth clearly cooled.

Inflation, meanwhile, did not cooperate. December PCE came in hotter than expected across the board. Headline and core both rose 0.4% month-over-month versus 0.3% forecasts. On a year-over-year basis, headline PCE accelerated to 2.9% and core to 3.0%. The GDP deflator also surprised to the upside at 3.7%. The key takeaway: price pressures remain broad-based. Goods prices rose 0.4% in December, but services — the category the Fed watches most closely — continued to climb 0.3%. Inflation may not be accelerating out of control, but it has clearly stalled above the Fed’s 2% target.

However, even this inflation data carries a “rearview mirror” quality. December readings predate some of the more recent moderation in housing and certain consumer categories. The University of Michigan's final February survey offered a more nuanced update. Consumer sentiment edged down to 56.6, below expectations, with current conditions softening. But the inflation expectations component improved meaningfully. One-year expectations fell to 3.4% from 4.0% in January, and five-year expectations held steady at 3.3%. That decline in short-term expectations may ease some pressure on policymakers, particularly if sustained.

The February flash PMI data adds another layer of complexity. The S&P Global Composite PMI slipped to 52.3, a 10-month low, signaling the slowest expansion in nearly a year. Manufacturing fell to 51.2, and services also cooled. Chris Williamson of S&P Global noted that weakened demand, high prices, and adverse weather all contributed to the slowdown. Notably, companies reported falling export orders and only marginal employment growth.

But perhaps the most important connection to the PCE data lies in pricing commentary. The PMI survey showed input costs rising sharply again, with tariffs and wage pressures cited as major drivers. Selling prices increased at the fastest pace since last August, particularly in services, where inflation hit a seven-month high. That aligns with December’s PCE strength in services inflation and suggests price pressures have not yet meaningfully rolled over.

In short, while GDP disappointed, inflation remains sticky enough to complicate the Fed’s path.

At the same time, the PMI data hinted that some of February’s softness could prove temporary. Severe weather disruptions weighed on output, and business expectations for the year ahead jumped to a 13-month high. Firms cited hopes for improved conditions, potential tax incentives, and lower interest rates. Whether that optimism proves justified will depend heavily on inflation’s trajectory and the policy response.

The bond market has reacted by pushing rate-cut expectations further into the back half of the year. Following the data and the tariff ruling, traders have repriced the first likely cut toward July or even October. The hotter PCE reading makes it difficult to argue for near-term easing, especially after the Fed’s January minutes signaled a higher bar for additional cuts. Policymakers emphasized they need “clear and convincing” evidence inflation is moving sustainably lower — something today’s data does not yet provide.

For equities, the SCOTUS ruling removes one source of uncertainty, but it doesn’t resolve the macro crosscurrents. Growth is slowing, inflation is sticky, and business surveys show rising price pressures even as demand softens. That combination — slower activity with persistent inflation — is rarely a clean setup.

The market may celebrate the legal win on tariffs in the short term. But as investors parse the economic details, the focus will likely shift back to the delicate balance between cooling growth and stubborn prices — and what that means for the Fed’s increasingly patient stance.