- Key driver of weakening GDP is a surge in imports, making net exports’ contribution negative.
- There are concerns about consumption and investment outlook as well.
- Growth markers may be weakening, but inflation remains sticky.
- Fed policy calculus would become challenging if such dynamics persist.
- Forthcoming tax policy measures would add further complication to the equation.
Related Insights
Commentary: Recession watch?
In a remarkable change in economic momentum over two months, the US economy is sputtering. The signs are noisy and could be subject to seasonality, but the fact is the first quarter of 2025 is presently on track to record a contraction over the previous quarter. Atlanta Fed’s real GDP Nowcast model is presently tracking minus 2.4% growth, annualised, for the quarter, a most striking fall from tracking nearly 4% just a couple of months ago.
The key driver of the contraction is a surge in imports, which makes net exports’ contribution of GDP substantially negative. This most likely reflects front-loading of exports ahead of a myriad of Trump tariffs. But there are also signs, both from surveys and actual data, of consumption and investment slowing amidst rising uncertainty about the policy environment. Public spending is also a source of concern, with a range of job rationalisation measures underway under the direction of Elon Musk. Some of the downside in the Atlanta Fed GDP tracker may fade as one-offs disappear, but these are extraordinarily opaque times for the growth outlook.
Markets have taken note. The S&P500 has given up all its gains since the November elections. Risk-on assets like bitcoin have sold off. Long-term bonds have gained. Market pricing for the Fed Funds rates, despite rising risks to inflation, has begun to move toward more rate cuts.
In his latest speech, Fed Chair Powell displayed little concern with regards to the economy or the need for imminent rate cuts. He conceded that some uncertainty has been created by President Trump’s escalating trade war, but kept the message about the Fed’s reaction function clear—the central bank would cut rates only after it is assured of the path toward 2% inflation. If the Fed stays steadfast in its inflation target, large number of rate cuts in 2025 would be unlikely.
The Fed appears not worried about the noise coming from layoffs in the public sector. Granted, through the end of February, there has been no discernible weakening of labour market indicators, with the February unemployment rate steady at 4.1% and wages up 4%yoy.
But consumers have gotten nervous and have begun postponing purchases, as seen by the surprisingly weak January retail sales data. University Michigan survey of consumers shows a sharp deterioration in confidence, while inflation expectations have risen both among consumers and businesses. It remains to be seen how the stagflationary mix of weakening consumer confidence and rising inflation expectations can sustain, but as long as trade war related noise persists, this may well be the making of things to come.
The upshot of the ongoing policy whiplash is that long-term interest rates have fallen in expectations of Fed easing, which has in turn weakened the USD. Mortgage rates have also eased a tad. These developments act as modest offsets to the erosion in asset values. We don’t think a recession is around the corner in the US, but an unpleasant combination of weaker growth and sticky inflation is certainly on the cards. This would create a range of policy complications, from monetary policy to tax cuts. No free lunch in macro management.
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