Lower U.S. growth, higher inflation
By our calculations, and with the potential for further tariff announcements, the average effective U.S. tariff rate could rise above 25%, well above the baseline we had anticipated at the start of the year. The global marketplace was far less integrated the last time tariffs were that high, more than a century ago. Although we don’t expect the rate to remain at that level given the prospect of negotiations, one that settles just below 20% (our baseline) still augurs significant economic ramifications. The effective U.S. rate before the latest tariffs was below 5%.
Under our revised baseline scenario, 2025 U.S. GDP growth would fall below 1%, nearly a percentage point below our previous forecast. That would put the economy at a potential “stall speed” that raises the specter of recession. We also foresee core inflation ending 2025 at nearly 4% year over year, more than a percentage point above our previous forecast. Unemployment that we foresee rising to just above 5% by year-end would be the highest in a decade outside the COVID-19 era.
The combination of stagnating activity and rising prices introduces the prospect of stagflation that would be a strong headwind for both stocks and bonds. Given their dual mandate, the Federal Reserve may be challenged to lower rates meaningfully amidst a push and pull of lower growth and higher inflation. In the end, the Federal Reserve is likely to lower rates in the event of the labor market weakening further.
Outside the U.S., we anticipate weakening economic growth, although softening demand will likely temper any inflationary impulses.
