US Economic Downturn Is More Likely
Recent policies are set to shake the economic underpinnings and raise the risks of a downturn.
US Economic Downturn Is More Likely
Recent policies are set to shake the economic underpinnings and raise the risks of a downturn.
Context
The economy has shown remarkable resilience over the past several years. Despite nearly double-digit inflation, and the rapid run-up in interest rates – the economy grew at relatively robust annualized rates. At the core of this performance has been consumer spending and labor market strength. Some of the economic strength can also be accrued to robust covid relief spending that takes a good bit of time to work its way through the system. Altogether, real economic growth has averaged 3.5%, more than 4.8 million new jobs have been created, and unemployment has averaged 4% during the past two years.
Recent evidence suggests that the economy may be drifting to a slower growth path. Job growth is slowing. During the past two months it has averaged roughly 150,000 net new jobs monthly. That is down from a level of 250,000 per month a year earlier. While job numbers can be volatile, the trend leans toward further weakening.
There are also signs that the consumer is struggling under the weight of inflation. Some suggest that the growth in consumer income has outpaced the growth in inflation – leading to an improvement in spending power. As a whole, earnings has outpaced inflation – but not for everyone.
Workers at the lower end of the income spectrum have been hit much harder by the rise in costs. According to the Bureau of Labor Statistics (BLS) inflation calculation, 36% of the inflation index is accounted for by housing. Food adds another 13%. At average household income levels, that translates into $2,500 monthly. In 28 states, the average housing cost alone is more than $3,000. Add food, clothing and other vitals it is easy to paint a picture where households, in some states, at the lower end of the spectrum are struggling.
It is no coincidence that defaults on credit cards, student loans, and mortgages are rising. Make no mistake, they are rising from historically low levels. But it does serve to point out stress that exists among consumer groups, particularly at the lower end of the income spectrum. Keep in mind, consumer spending performance is measured at the margin. A small two percentage point swing can mean the difference between a healthy and not so healthy consumption sector. Stress among the lower income spectrums can be large enough to turn the story from good to not so good.
Consumer spending overall accounts for more than two out of every three dollars this economy generates. With a decay in consumer spending, slower overall economic growth is likely. All this partially explains the slowdown in job creation going forward. By itself and given the resilience of the economy, it is not enough to push the economy into a recession. An economic slowdown – absolutely. A recession – probably not.
Key Administration Policies Impacting the Near-Term Economy
Aside from recent policies by the administration, the economy is becoming fragile. Left alone, economic growth would likely settle near 1% to 1.5% growth during the first half of 2025. In the context of continued improvement in inflation and sustained, albeit modest reductions in the Federal Funds rate, stronger growth could materialize in the second half of 2025.
That is now off the table.
Immigration, DOGE, and tariffs have dramatically changed the landscape. The adverse impact of each policy on economic growth might not be strong enough to push this fragile economy into recession. The combination of the three, however, could exert an adverse impact on economic growth strong enough to make negative economic growth materialize this year a very real possibility.
Consider.
Uncertainty is rising among consumers and businesses. Consumer surveys, such as The University of Michigan’s Consumer Sentiment’s, recorded a decline in February. Business surveys, such as The National Federation of Independent Businesses, reported an increase in uncertainty in the business environment unmatched since Covid. Industry surveys, such as The Homebuilders Index, reflected similar weaknesses.
These surveys, all from different viewpoints, are all singing the same tune. The economy does not perform well in the context of high degrees of uncertainty. Are you going to buy a new car if your job is threatened? Invest in your business if things might sour? The questions are endless. Uncertainty, by itself, brings about a resistance to economic activity and growth.
Policies undertaken by the new administration have contained a lack of clarity. Tariffs, for example, were threatened publicly, retracted, expanded and re-timed. Some still dismiss tough talk on tariffs as “the art of the deal” as part larger administration objectives. Similar arguments regarding uncertainty can be made with respect to the clamp-down on illegal immigration and DOGE.
Near term, the implementation of tariffs hold the greatest adverse impact on near-term economic growth. Let’s not dismiss these policy initiatives as empty “tough talk”. These policy initiatives arguably hold the potential for heightened longer term growth (subscribers should stay tuned for a discussion on that topic). For now, let’s only focus on near-term impacts and how they relate to the prospects of an economic slowdown.
A treatise could be written on the impact of each of the tariffs that are either in place or scheduled to be in place soon. That’s not what this article is about. It’s about the potential impact on near-term economic growth. For these purposes, let’s focus only on the automotive tariffs.
The selling price for the average imported light vehicle sold in the United States is $49,000. Imports account for 50% of total vehicle sales. If manufacturers and retailers maintain their pre-tariff margins, a 25% tariff implies an average increase in price of $12,160 per imported vehicle.
Domestic producers will likely increase their prices as well – either because component costs have increased or to take advantage of the situation to improve margins. Let’s assume for every 5% import prices increase; domestics increase by 1%. Combined that implies a 15% increase in the average price for all vehicles. According to the Bureau of Labor Statistics (BLS), vehicle purchases account for 7.4% of the total weight used in calculating the Consumer Price Index (CPI). Combining these calculations, the 25% tariff on imported finished vehicles initially boosts the inflation rate by 1.1%.
Furthermore, strategic plans in the automotive industry are “North American” focused. Each country – the United States, Canada and Mexico - play a role in suppling parts and components to the end-product. Furthermore, investment decisions are often made considering the economies of scale in servicing the continent – not an individual country. This sourcing strategy is more-or-less true for the North American automotive industry. Anything that disrupts this planned sourcing pattern disrupts supply and adds cost to the product. In determining the impact of automotive tariffs parts and components matter. This disruption in the supply chain adds to the economic cost of the tariffs.
At this point some will argue it’s a one-time charge and not inflationary. They either miss the point or intentionally use semantics to confuse (that’s another topic in queue for subscribers). The point is consumer spending is significantly hindered – no if’s and’s or but’s. This additional adversity comes at a time when economic growth is becoming increasingly vulnerable. By itself, even this partial analysis of the tariff policies could be enough to push a retreat in economic growth. Tariff retaliation by trading partners darkens an already dark story.
Other policies of the administration heighten uncertainty and weigh against near-term growth. From a strict economics point of view and putting legal issues aside, the tightening of illegal immigration adds to supply challenges in critical industries. Agriculture depends on these laborers. So does construction. So do services. Lacking the labor force to bring products to market either raises the cost of providing or limits production/supply. Both reduce output, reduce economic growth and add to inflation. Finally, while DOGE may offer beneficial long-term benefits to the economy, in the neat term it will add to unemployment (subscribe to read the forthcoming discussion on the threat of the federal debt).
The combination of these three policies exerting an adverse impact on economic growth may be enough to make negative economic growth materialize during this year a very real possibility.
The Federal Reserve: Late to the Rescue
A significant slowdown from recent economic growth levels is expected soon. Typically, such a slowdown would usher in an easing in monetary policy and lower interest rates. These policy actions, in turn, could support a recovery and avert a retraction in economic growth.
Unfortunately, this rosy scenario is not going to happen.
The Federal Reserve has a dual mandate – to keep prices and unemployment in check. US policies regarding trade, tariffs, and immigration have increased the prospects of higher inflation. It will take a bit of time for these adverse policies to impact jobs. Because of their inflation concerns, this will likely delay any moves by the Federal Reserve to lower rates. Initially, the Federal Reserve will likely sit on the sidelines and keep interest rates unchanged. Only after the threat of a more significant decline in economic growth and labor market weakness raises its head, will the Federal Reserve slowly act to lower interest rates.
A lot of time has to pass for all that to happen. Any action to cut rates will not materialize until the second half of 2025 – if then. At that point, the cow is out of the barn (I am never sure what animal escaped but I know it’s a bad thing). Adverse economic momentum, once in place, is hard to reverse. Initial steps by the Federal Reserve to lower rates will likely be modest (25 basis point). This implies a policy of too little, too late to save a recovery for the US economy.
Economic growth could turn negative. Some may refer to it as a recession (yet another coming discussion for subscribers). But in the context of rising inflation, this suggests a mild form of “stagflation” whereby the economy experiences the concurrent malady of rising unemployment and inflation.
Actionable Considerations
No one has a crystal ball. These are my current thoughts regarding a likely outcome of how the economy will unfold in the near term. Policy reversals or modifications could occur – changing the likely outcomes. For now, based on the foregoing analysis, these are a few things to consider.
· Play nice at your job. According to my initial calculations, monthly net job losses could begin as soon as the third quarter. The rate of job openings could ease. Unemployment could eventually approach as high as 5%. In this context, wage gains may be slow in coming and bonuses may be harder to achieve.
· Create a family budget action plan. Think how you might trim expenses. Consider adding “gigs” to supplement income if needed.
· Don’t expect interest rates to move significantly lower soon. If you are waiting for significantly lower rates to buy a home, etc. – they may not materialize until 2026.
· Consult your investment portfolio professional, as this may be a time to add an extra dose of conservatism into your portfolio.
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Brief Bio
Ed Sullivan was recently Chief Economist and Senior Vice President of Market Intelligence for the American Cement Association (formerly PCA). Ed’s analysis and views regarding the construction, cement and concrete industries are widely used in corporate planning efforts, the financial industry, and media.
The Chicago Federal Reserve has cited Ed for his forecast accuracy. Various other forecasting surveys have placed Ed among the most accurate construction economists in the country. Over the years, various trade magazines have named Ed a “key influencer” in the domestic and international cement and concrete industry.
In the past, Ed has held the position of Vice President at Chase Manhattan Bank Economics, Standard & Poor’s, and Wharton Economics, where he worked with Nobel Lauriat, Lawrence Klein. Ed has lectured at The War College, Fordham University, Fairfield University, Manhattanville College, Villanova and St. Joseph’s University.
Ed has played supportive analytical roles in major US trade policy including Japan's Voluntary Automotive Export Restraints and NAFTA. His background also includes positions as a senior intelligence officer at the Central Intelligence Agency, where he was awarded a commendation from Bob Gates (then Deputy Director of Intelligence and later Secretary of Defense).