US outlook shifts from solid growth to recession risk

The stockmarket went off a cliff last week after US President ­Donald Trump announced the highest tariffs in more than a century.

Elon Musk, wearing a red Trump cap, looks on during a cabinet meeting at the White House. Picture: AFP

The stockmarket went off a cliff last week after US President ­Donald Trump announced the highest tariffs in more than a century, vaporising more than $US6 trillion of wealth in two days. Whether the real economy will follow is impossible to know. But the risks are tilting in that ­direction.

The available evidence suggests US economic fundamentals remained strong through March. Job growth accelerated, with non-farm payrolls rising 228,000, unemployment low at 4.2 per cent, wages rising at a healthy clip and lay-offs rare.

But the world changed last Wednesday, which Mr Trump dubbed Liberation Day. He ­announced massive tariffs on ­almost every country – effectively the largest US tax increase since 1968, according to JPMorgan. On Thursday, US markets suffered their steepest declines since 2020, with the S&P 500 falling 4.8 per cent. On Friday, China retaliated with 34 per cent additional tariffs on all goods imported from the US, and the S&P 500 plunged an additional 6 per cent.

The stock declines, a parallel sell-off in junk bonds, the cost of tariffs, and the prospect of weaker exports from retaliatory tariffs all now weigh on the outlook.

In a note titled There Will Be Blood, JPMorgan’s head of economic research, Bruce Kasman, raised the probability of a global recession to 60 per cent from 40 per cent. The bank expects US gross domestic product to contract 0.3 per cent in the fourth quarter of 2025 from a year ­earlier; it previously expected 1.3 per cent growth. Unemployment will reach 5.3 per cent next year, JPMorgan says.

“The size and disruptive impact of US trade policies, if sustained, would be sufficient to tip a still healthy US and global expansion into recession,” Mr Kasman said. “The tariff shock will likely be magnified by its effect on sentiment and through potential disruptions to global supply chains.”

Nomura chief economist David Seif said he hasn’t seen enough data to forecast outright recession, often defined as two consecutive quarters of contracting GDP. But that doesn’t mean it won’t feel like one.

“Real consumption could be extremely anaemic, and it could feel worse for people than the GDP numbers indicate,” Mr Seif said. He predicts GDP will grow 0.6 per cent in the fourth quarter from a year earlier.

Mr Trump says his tariffs will bring American jobs back from overseas. That is hotly debated, but even if true, the tariffs will likely first weaken household spending, which drives 70 per cent of GDP.

The duties unveiled by Mr Trump on April 2 will raise the ­average effective US tariff rate from 2.5 per cent in 2024 to around 22.5 per cent, according to the Yale Budget Lab. Combined with narrower tariffs Mr Trump imposed in February and March, that will push up prices by 2.3 per cent in the short run, equivalent to $US3800 less purchasing power for the average household. That will shave about 0.9 percentage point from fourth-quarter GDP growth from a year earlier, said Ernie Tedeschi, director of economics.

What is unpredictable is how the resulting uncertainty will affect behaviour, Mr Tedeschi said.

Mr Trump has argued since the 1980s that the global trading system was rigged against the US. Still, until last week much of Wall Street hoped that Mr Trump saw tariffs as a temporary negotiating tactic rather than permanent, in part based on messaging from Mr Trump and some aides, including Treasury Secretary Scott Bessent.

Goldman Sachs said on March 20 that a survey of investors showed the market expected ­average US tariffs to rise 8.6 percentage points over the course of 2025. As of April 2, Mr Trump has raised them nearly 20 percentage points.

Mr Trump said on social media last week that his policies never change, suggesting negotiations were off the table. But on Friday, Mr Trump claimed Vietnam had offered to eliminate its tariffs in return for a deal. Markets interpreted that as a willingness to negotiate, sending up the shares of Nike which sources from Vietnam. Such dissonance adds to the uncertainty and makes companies reluctant to make major investment decisions, further sapping aggregate demand, economists said. “I think the reason you see so much market turmoil is precisely because businesses don’t know what tariffs are going to be an hour from now,” Mr ­Tedeschi said.

The US economy has been the envy of the world in recent years. Growth has averaged nearly 3 per cent since 2022, outpacing America’s global peers and silencing doubters who predicted aggressive interest rate increases by the Federal Reserve would cause a ­recession.

That appears to have made some economists hesitant to call a recession this time around. “We all cried wolf, but the wolf didn’t appear,” economist David Shulman said.

But compared with the most recent wave of recession fears in late 2022 and 2023, the labour market is on softer footing. Low-income household finances have been strained for months, and loan delinquencies have been creeping up.

There is also less prospect of relief from policymakers than during previous economic shocks. When the coronavirus pandemic forced much of the economy to shut down in early 2020, congress authorised trillions of dollars in relief and stimulus, while the Fed slashed interest rates and backstopped lending.

These days, however, Elon Musk’s Department of Government Efficiency is slashing federal payrolls and suspending contracts. Congressional Republicans are struggling to reconcile their goals of cutting taxes while narrowing the budget deficit. A significant deficit reduction could mean an additional drag on the economy.

As for the Fed, in most downturns, slowing growth leads to easing price pressures and gives the central bank comfort to lower interest rates.

But when the shock comes from higher prices, such as for oil during the 1970s or tariffs now, inflation may pick up even as the economy turns pear-shaped. The result, stagflation, leaves the Fed less sure which way to move rates.

If the hit to inflation proves temporary and inflation looks set to resume its decline toward the Fed’s 2 per cent target, policymakers could bring the economy back from the precipice by cutting interest rates.

But if consumers and businesses expect higher inflation to continue, the Fed would likely avoid cutting until clear signs of weakness emerge, at which point it could be too late to stave off a recession.