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

iStock; Tyler Le/BI 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. Consumer likely cools 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. In addition to losing the tax-refund boost, American households will soon be forced to deal with a larger geopolitical uncertainty tax in the form of higher gas and food prices. As the war in Iran drags on, higher commodity prices will bleed into the prices you pay at the pump and at the grocery store. One way to gauge the shock is to compare movements in headline and core inflation — the former includes all goods, while the latter strips out food and energy prices. In the last three months, the gap between the two measures has narrowed, suggesting that the price pressure from gas, eggs, and their ilk is declining. However, signs suggest that the rest of the year will be a bit more challenging. On energy, prices for refined energy products have been rising. Nationwide retail gasoline prices are up $1.25 per gallon on average compared to the same time of year. This is particularly alarming since energy prices typically fall at this point of the season, thanks to the end of the summer driving surge. Next, the rise in diesel prices and agricultural commodity prices, two important cost drivers for farmers and other parts of the agricultural supply chain, means grocery store prices will almost certainly accelerate into year-end. In short, the "shock tax" that Americans feel at the pump and the grocery aisle will only increase over the rest of the year. The final headwind to consumer spending is set to come from the housing market, as mortgage rates climb and the number of Americans moving stalls. Home sales were already slowing before the latest run-up in mortgage rates, which have recently topped 7% for the first time in over a year. And as home sales slow, so too do purchases of major household goods like furniture, appliances, and carpeting. It usually takes six months for the slowdown in home sales to filter down into decreased spending on big-ticket items, which is important, since the contribution from furnishings and durable household equipment punched above its weight in the second quarter. The slowing in home sales over the past few months implies this good news will turn sour by year-end. Fading fiscal relief, a rising geopolitical tax, and a decline in people moving homes, all in the context of relatively sluggish growth in wages and salaries, imply that household consumption growth will probably moderate into next year. Consumption is an important part of US growth, and, importantly, many more jobs are tied to consumer spending than to business investment. If people don't buy as much stuff, firms don't need to produce as much stuff either. The Fed keeps squeezing At the same time that American consumers are tightening their purse strings, the Fed is tightening as well. The central bank raised interest rates on Wednesday, and despite the ho-hum market expectations, additional hikes are likely on the horizon. Continued hikes are likely to slow the economy. That is ultimately the point of tightening monetary policy — to slow demand and bring consumer prices to the inflation target. The main reason for the anticipated hikes to come is that inflation progress has stalled. Core inflation remains above 3% and is only projected to approach that target years down the road. And while current inflation numbers aren't great, I think the bigger story is the balance of risks in the inflation outlook. It's difficult to find a reason inflation will meaningfully cool off anytime soon, which increases the risk of it becoming entrenched. When people start to believe more price hikes are on the horizon, they are more likely to swallow that inflation, and it becomes harder to squash. So the recent rise in short-run inflation expectations, which are climbing alongside energy costs, presents a challenge for the Fed. Beyond expectations and the rise in staple prices, other important drivers of the recent increase in inflation also look set to heat up. For instance, the price of semiconductor chips — the critical tech fueling the AI boom — has boosted core PCE inflation by 0.6 percentage points over the past six months, and there is no sign of the bottleneck improving anytime soon. In the face of consensus about the economy, it's always important to be cognizant of what could upend the apple cart. Based on my reading of the consumer winds and the Fed's renewed dedication to tackling inflation, it's clear that there are two serious reasons to think the US is on shakier ground than it appears. Neil Dutta is head of economics at Renaissance Macro Research. Read the original article on Business Insider

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