Resilient U.S. GDP Diminishes January Rate-Cut Prospects

The U.S. economy has defied expectations, with Q3 2025 GDP growth surging to an annualized rate of 4.3%, far exceeding the 3.3% forecast and marking the strongest expansion in two years. This resilience, driven by robust consumer spending, a rebound in exports, and government outlays, has recalibrated market expectations for Federal Reserve policy in 2026. While the Fed had previously signaled a path of rate cuts to accommodate a soft landing, the latest data has dimmed the likelihood of a January 2026 rate reduction, forcing investors to reassess their positioning in a landscape increasingly shaped by AI-driven growth and uneven sectoral performance.

Reassessing the 2026 Fed Policy Path

The Federal Reserve's December 2025 policy meeting underscored a cautious approach, with officials cutting the federal funds rate by 25 basis points to a range of 3.50-3.75%. However, the Q3 GDP report-a surprise 4.3% growth-has shifted the narrative. Markets had initially priced in four rate cuts for 2026, but the probability of a January 2026 cut has plummeted to just 15%, with the Fed now expected to hold rates steady. This recalibration reflects the central bank's data-dependent stance: while inflation remains near 2%, the Fed is wary of overstimulating an economy that continues to outperform expectations.

The Fed's January 2026 meeting, scheduled for January 28-29, will likely prioritize monitoring labor market dynamics and inflation trends. Despite a slowdown in job gains and a rising unemployment rate, the broader economic backdrop-bolstered by AI-related investments and fiscal stimulus-suggests the Fed will avoid aggressive intervention unless risks crystallize.

By year-end 2026, the funds rate is projected to reach 3-3.25%, a reduction of 50 basis points from current levels, but this path hinges on a delicate balance between supporting growth and curbing inflation.

Asset Allocation in an AI-Driven Recovery

The Fed's measured approach aligns with a broader K-shaped recovery, where AI-driven sectors outperform traditional industries. J.P. Morgan Global Research highlights that AI-related capital expenditures surged to over 7% of GDP in 2025, fueling expansion in technology, utilities, healthcare, and logistics. This divergence necessitates a strategic shift in asset allocation, with investors overweighting sectors poised to benefit from AI adoption while underweighting those facing structural headwinds.

For instance, technology and AI infrastructure firms are likely to see sustained capital inflows, driven by both private investment and government incentives. Meanwhile, non-AI sectors-particularly those reliant on traditional labor models-may face stagnation or contraction as the labor market shifts toward automation. Edward Jones reinforces this view, noting that fiscal stimulus and lower interest rates in 2026 will further amplify AI-driven growth, making diversification across high-tech industries a priority for risk-adjusted returns.

Global diversification also remains critical. While U.S. GDP is projected to grow at 1.75% in 2026, global trade tensions and geopolitical uncertainties could disrupt supply chains and inflation dynamics. Investors should balance exposure to AI-centric U.S. equities with defensive assets in international markets, particularly in regions where AI adoption is accelerating but valuations remain attractive.