Tariff tumult: reassessing the US economic outlook

Market & Trading Calls

• Downward Growth Revisions: We revise lower 2025 US GDP growth to 0.8% and raise the probability of recession to 50% reflecting increased short-term economic risks following aggressive tariff policy. Inflation is likely to remain elevated in a range between 3.2 – 3.5%. The equity market selloff reflects concerns around US growth prospects.
• Bond Market Volatility: The bond market is being whipsawed between growth concerns and inflation risks. After the initial tariff announcement last Wednesday (April 2nd), 10y yields fell 13bp, a clear reflection of weakening US growth prospects. However, 10y yields have since surged higher 40bp this week while short-term yields have lagged behind, steeping the 2s – 10s curve to its highest since early 2022. This reflects both investor expectations for rate cuts (short end), but also concerns about inflation, fiscal sustainability, and possible foreign selling (long end).
• Fed Unlikely to Aggressively Cut: The market has eased back a bit from Fed cut rate expectations as concerns about inflation remain front of mind and Trump delayed reciprocal tariff implementation for 90 days (excluding China). We expect the Fed will chart a cautious path ahead.‍
• Re-Shoring Uncertainty: The Trump administration appears to be betting that short-term pain from tariffs will result in medium- and long-term gains through investment re-shoring and trade rebalancing. While a worthwhile endeavor, we are not convinced of this outcome, at least for now. If the aim of the White House is to truly reduce the trade deficit, additional policy implementation will be required, including an easing in immigration restrictions, taxing non FDI inflows, focusing on a clear industrial policy, and limiting tariff implementation to large net surplus economies.

Market Analysis

We revise lower our US GDP growth expectation to 0.8% and raise our chances of a recession to a 50% probability.

Over the past two years, the economic narrative for the United States has been one of “outperformance.” With real GDP growth averaging just under 3% annualized in real terms, America was managing an expansion that outpaced the historical norm by nearly 100bp. Of course, the narrative has shifted significantly amid volatile US tariff implementation. The Trump administration has decided to chart a risky path – nearly assured short-term economic pain in the hopes that manufacturing investment and production is re-shored to the United States.

Last Thursday we released an updated view of US GDP revising lower growth expectations to just 0.8% for 2025, down from an expectation of 2% in early March and 2.5% entering the year. We also increased the probability of a US recession to 50%, up from just a 1-in-5 chance and we revised up our core CPI-based expectation to a range between 3.2 – 3.5%. Immigration restrictions, and continued elevated deficits, alongside aggressive tariffs, are all inflationary factors, even amid a slowing growth environment.

Yearly US Headline Real GDP Growth (%)

Source: Kpler, various statistical agencies

Ultimately, if US tariffs remain in place, short-term (6 – 12 months) economic pain appears extremely likely. The extent of that pain is an open question. As mentioned, we have taken the official view that US GDP will expand 0.8%, still in positive territory, but well below the long-run average (2%). Consumption, at 68% of GDP, will be the critical factor for just how much Americas economy decelerates this year.

The equity market is certainly indicating deep concerns over a potential US growth slowdown. As of 10AM CST on April 9th the S&P 500, a broad-based US equity index, was down 12% over a five day trading period. Technology (-12.5%), consumer discretionary (-12.9%), and materials (-14.2%) have struggled mightily, while consumer staples (-6.4%), have managed to hold up a bit better.

Relative US S&P Index Performance Against Nov 1 2024 Baseline (%)

Source: FMP

The bond market has been decidedly more mixed in its economic messaging. The 10y US government yield initially fell nearly 13bp following the tariff announcement, briefly testing 4% for the first time since early October of last year. However, through the first thee days of this week, 10y yields have surged higher. Short duration yields, which also declined in the initial aftermath of the tariff announcement, have since rallied far less over the course of this week. The 2s-10s spread is now trading at the steepest since early-2022. This is indicative of a market that is jointly pricing in more rate cuts, while also expressing concerns about inflation and fiscal sustainability. The 10y might also be facing selling pressure from China, albeit the extent to which this is happening is unclear. If this story is true, the Fed might be forced to step in and slow the balance sheet roll off via QT.

Nonetheless, inflationary concerns could make it difficult for the Fed to imminently restart the cutting cycle, even with a weakening growth environment. The labor market, at least for now, remains stable, and inflation has reaccelerated from late last year. In our view, the market is far too aggressively pricing in monetary easing. CME futures trading was pricing a >60% chance of at least 100bp of cuts through the end of 2025. The Fed is more likely to wait rather than moving too early.

US Six Month Rate of Inflation (%, Annualised)

Source: BLS

Probability of at Least 100bp of Rate Cuts by End of Year (%)

Source: CME

We continue to watch for weakening signals of household consumption as a barometer for the US economy in the short run.

Ultimately, the extent of short-term US economic pain will be determined by the household consumer (69% of GDP). If the labor market can hold up decently well, and consumers are willing to “spend through” inflation in goods prices, growth will fare better. Unfortunately, even before the April tariff announcement, signs were pointing towards slowing consumption growth. In January, inflation-adjusted personal expenditures fell 8.7% m/m annualized, the largest decline since early-2021. While spending recovered into February (+1.6% m/m annualized), this marked a relatively tepid increase after the weakness seen a month earlier.

Consumer survey data has also indicated signs of weakness, albeit one must be cautious in extrapolating too much given the biasing effects of political leaning. A YouGov/Economist poll examining consumers assessment of the economic environment has seen those indicating the economy is worsening rise from 37% at the start of this year to nearly 46% of the sample as of early April. Services PMI figures through March, while still in expansion, were structurally below levels seen in Q4, and University of Michigan sentiment figures have also declined.

Monthly US Real Consumption Expenditures (USD tn, top) and M/M % Delta Annualized (bottom)

Source: BEA

However, at least for now, the US labor market continues to hold up. Jobless claims are roughly in the range seen over the past two years. Job openings have weakened so far this year but remain above the 2024 lows seen in September. In the March jobs report, total nonfarm payrolls added a solid 228k m/m, the highest pace of increase in three months.  For now, we will have to wait and see how consumer data evolves into the summer.

The extent of investment and manufacturing re-shoring are major questions over the medium- and longer-run.

The Trump administration is making a risky bet by implementing such an aggressive tariff regime, which guarantee short-term pain, with the intention of driving up medium- and long-run investment reshoring. The extent of this re-shoring will be a major determinant for whether tariff policy is successful. At present we are skeptical. A lack of certainty from the Trump administration, steadily rising congressional pressure, and aggressive immigration restrictions are likely to make the prospect of American investment a difficult one, at least for now.

Nonetheless, if Trump keeps to his tariff policy while simultaneously pursuing additional initiatives, more re-shoring could take place. This could include things such as taxing foreign capital inflows not meant for direct investment, finding ways to redistribute income “downwards” towards the lower and middle income classes, and focusing on a clear industrial policy. Adjusting tariffs to focus on net surplus economies could also help.

Yearly Average US Industrial and Manufacturing Production Indexes

Source: Fed

While Trump’s policy implementation has been somewhat chaotic and incongruent, White House aims to narrow the trade deficit with the rest of the world are not necessarily misplaced. American industrial production has flatlined since the 2008 Recession, and the US goods trade balance has grown ever more negative as net surplus countries, including China and Germany, rely heavily on demand from the United States to absorb excesses. Simply put, America far out consumes its domestic productive capacity. Rebalancing with investment as a slightly higher percentage of US GDP could bring benefits in the form of a higher long-run growth rate, higher wages, and a healthier labor market. Whether this re-shoring impulse actually happens is an open question and presents distinct risks. If investment is not reshored, America will be faced with a lower growth environment, a far higher permanent price level, a potentially higher inflation rate, and ongoing geopolitical concerns around productive capacity.

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