U.S. Quarterly Economic Forecast

The world has been on the edge of its seat as President Trump feverishly implements an agenda that saw 90 Executive Orders in the first 60 days. Much of the focus thus far has been on policies that will weigh on economic growth – the dramatic cuts by Elon Musk’s DOGE to rein in government spending, and on-again, off-again tariff threats. The positive impulses are yet to come from de-regulation and tax cuts. Given the limitations to government finances, we don’t think new tax initiatives will be of a magnitude to fully lean against the complex and forced reorganization being initiated by the administration. Right now, markets are of the same view. Uncertainty on trade policy has soured sentiment among investors, sending the S&P500 into correction territory (Chart 1). Navigating uncertainty is the name of the game right now. Our global forecast is based on the U.S. tariff and other policy assumptions outlined in the text box below, which we believe balance the upside risk that tariffs will settle at lower levels, or have a shorter shelf life against some trading partners, with the downside risk that they are more punitive or longer lasting. 

It’s not just investors’ whose moods have darkened, consumer and business confidence measures have also come off highs from when Trump was first elected (Chart 2). This has occurred despite the U.S. economic data painting a resilient picture. The job market has remained solid relative to history. The unemployment rate has remained steady between 4-4.2% since last summer. Economic growth in the fourth quarter outperformed our expectations with a solid 2.3% pace. 

We would have been releasing an upgrade to our U.S. 2025 outlook if not for the confidence hit from policy uncertainty, a higher effective tariff rate on imports and greater government restraint. The slowdown in economic growth causes the unemployment rate to be slightly higher. This estimate would have been higher if not for softer labor force expansion from weaker immigration, which we expect to fall from 2+ million in 2023-24 to 500 thousand by 2026. We also pared back growth in government spending given DOGE’s aggressive cost cutting that has spending and employment knock-on effects to the private sector and non-for-profit institutions. And lastly, residential investment was downgraded due to the persistent high interest rate environment that’s made more complex by weakened confidence and a higher cost structure, as tariffs feed into nearly all aspects of home building (steel, aluminum, lumber…and all the production byproducts that include window frames, appliances and so forth). 

One of the few indicators to receive an upward revision was exactly where it’s least wanted – inflation. Our December forecast embedded an effective U.S. tariff rate of 7.5%. With the mark-up to 14% for a six month period and a gradual decline thereafter, the Federal Reserve’s key inflation gauge (core PCE) now peaks at 4.3% annualized by Q2. As a result, the Fed will have to walk a tight rope in providing some support to a weakening economy, while also being mindful of higher inflation expectations becoming embedded on a longer term basis. We expect only two rate cuts with a return to our neutral rate assumption of 3% delayed until next year. 

Trump Spurs Global Policy Action

Overall, global growth has been downgraded this year and next. U.S. tariff risks are depressing sentiment, affecting most major trading economies. One of the biggest changes to our forecast resides within Europe. Germany is expected to deliver a fiscal U-turn, increasing infrastructure spending and looking to exempt defense spending (above a threshold) from their debt limits to enable higher levels of military expenditures (see table). Given typical lags in getting money out the door, the boost isn’t expected to show up until late-2025. In the rest of the European Union, the uptake on newly allocated funds for defense spending presents an upside risk to the outlook and is not currently incorporated due to the lack of details. 

China has seen the biggest actual increase in U.S. tariffs to an additional 20%. And yet, it recently established a “roughly” 5% growth target for this year, which includes increased government stimulus. Given the headwinds to the economy and ongoing structural issues, it remains to be seen whether the proposed stimulus measures will be sufficient to meet the growth target. As in 2024, if growth is seen as falling short, there will likely be more ad hoc spending measures to support the economy.