Economic News – March 2025

The One Certainty This Year Is… Uncertainty.

It would be wonderful to say that the economy started 2025 with a bang, setting the stage for another year of solid performance. Sadly, that’s not the case, as key data on activity weakened and inflation jumped in January. Happily, one-month does not make a trend, so it would be a mistake to extrapolate early-year numbers into the future. For one, data for January are less reliable than in other months. That’s particularly the case since COVID, which greatly disrupted seasonal price and spending patterns, and has complicated the task of seasonally adjusting new data. For another, climatic conditions are more unpredictable in January; the presence of devastating wildfires and extreme cold this year made interpreting the data even more of a chore.

Additionally, the slew of executive orders and tariff proposals by the Trump administration is still reverberating through the economy. It will take time to process the impact these rapid-fire directives would have, and whether they are just a negotiating ploy or firm commitments that result in real changes. But uncertainty can affect behavior; plans can be put on hold, households can either defer or pull forward spending and, importantly, rate-setting plans by the Federal Reserve can be put in limbo. Indeed, the central bank has already moved to the sidelines, pausing its rate-cutting campaign at the January meeting.

There are still reasons to be optimistic about 2025. Most notably, the job market is churning out paychecks at a sturdy pace, providing households with the firepower to sustain spending. Consumers account for about two-thirds of economic activity, so as long as they keep their wallets open there is little risk that the U.S. will fall into a recession. That’s not the case for other parts of the world, as growth in Europe and China is sluggish at best and facing much of the same set of uncertain conditions as the U.S. Chief among them is the possibility of an all-out trade war, which would not only throw shade on the already shaky global outlook, but would also have unintended consequences for the U.S., much of which would be negative.

Extensive Tariff Rollout

It’s been a little over a month since President Trump took office, but it is hard to identify another post-election period crammed with as many executive actions in so short a time. As promised in his campaign, Trump is determined to use America’s economic muscle to reset trade relations and accomplish other non-trade related goals, such as coaxing trade partners to tighten their borders and stifle the outflow of drugs to the U.S. To this end, the main cudgel being employed is the threat of higher tariffs on goods Americans purchase from abroad.

As of this writing, the White House is rolling out an eye-opening roster of tariffs. Chinese imports have been hit with an additional 10% tariff on all imported goods; the suspended 25% tariffs on Mexico and Canada are scheduled to be re-imposed on March 1st; a 25% tariff is set to be imposed on steel and aluminum imports from all foreign sources beginning March 12th. Plus, an official study of reciprocal tariffs, in which the U.S. matches the tariffs imposed on it, is due April 1st. The president has also threatened additional tariffs to include the European Union, as well as motor vehicle and pharmaceutical imports.

It’s quite possible that some – if not most – of the dizzying array of tariffs will be reduced, postponed or removed entirely if trading partners make the concessions demanded by the administration. Alternatively, the response by other nations could be hostile, resulting in tit-for-tat retaliations, leading to a destructive trade war with unpredictable consequences on inflation and global growth. One thing is sure: the possibilities are broad, and the uncertainty being generated is huge. An index revealed by the Federal Reserve Bank of Atlanta shows the current level of uncertainty to be higher now than prior to the onset of the past four recessions.

Uncertainty Is Problematic

There is an old saying that Wall Street abhors uncertainty. Traders and investors want to have a reasonable understanding of what policies they will be operating under and then assess how those policies will affect profits, inflation, and the specific industries or sectors they are paid to follow. Sometimes those assessments are correct; other times they are not, and the people making the judgements are rewarded or penalized accordingly. But when the rules of the game are unknown, analysts are hard-pressed to put their skills to use, underscoring their abhorrence of uncertainty. In turn, this fog of uncertainty generates heightened market volatility and increases investment risks on Wall Street.

Main Street also abhors uncertainty, and this is where it can induce real changes in behavior. If businesses are uncertain what their costs will be in the future – something that is clearly impacted by tariffs – they might put investment plans on hold and freeze hiring. The potential for such altered behavior has already appeared in numerous quarterly earnings calls over the past several weeks; that includes the nation’s largest retailer and private employer, Walmart, whose Chief Financial Officer noted that “We are one month into the year, and there’s a lot that we don’t know,” regarding tariffs and how shoppers might react.

Importantly, small firms are just as vulnerable – if not more so – to policy uncertainty than their larger counterparts. Those reliant on imports have fewer options when trade tensions escalate, as larger corporations can more easily relocate their product sourcing to other countries that aren’t in the crosshairs of newly imposed tariffs. Nor are tariffs the only policy uncertainty small businesses face. The prospect of mass deportations would cut deeply into the labor supply and pose a major problem, particularly for the construction industry, which is a dominant small business employer, and heavily reliant on unauthorized immigrant workers.

Who Let The Doge Out?

To be sure, resetting trade relationships through tariffs is only one of the top priorities of the new administration. Getting a handle on the burgeoning fiscal deficit – and reducing the monumental $36 trillion in Treasury debt – is also high on the list, with President Trump and his advisors hoping to cut the red ink dramatically during his term. The revenues expected from tariffs are part of the plan, as some of it would be used to pay for planned tax cuts. However, the main thrust behind the deficit-reducing effort is coming from the spending side of the ledger, as the administration is hoping to slash $2 trillion from the $6.7 trillion in annual federal outlays.

The responsibility to identify those savings has been bestowed upon the newly created Department of Government Efficiency (DOGE). Aside from attention-grabbing headlines – eliminating government agencies, slashing federal payrolls, canceling contracts, amongst others – very little in the way of savings has been accomplished thus far. Importantly, budgetary experts believe not much can be saved without cutting into sacred entitlement programs that most lawmakers are loathe to touch.

Recently, the administration suggested the potential of a “DOGE Dividend” if the $2 trillion target is met, in which 20% of the DOGE savings would be used to provide a direct payment to taxpayers. The aim is to inject stimulus into the economy to offset the drag in growth brought about by $2 trillion in spending cuts. However, if the use of previous stimulus disbursements is any indication, most of the estimated $40 billion in dividends (20% of $2 trillion) would be used to pay down debt or saved. Still, if only 25% of the payments were spent (similar to the last round of stimulus) with the economy at nearly full employment, the main effect would be to add to inflation and widen the trade deficit, sabotaging a key objective of tariffs.

Cloudy Crystal Ball

Needless to say, trade and fiscal policies are wild cards in the outlook for 2025, and beyond. The betting is that the full package of tariffs and spending cuts being proposed has little chance of coming to fruition. But that has not stopped speculation nor stemmed the upsurge in uncertainty that is resonating though financial markets, corporate board rooms, and households, whose inflation expectations have started to climb sharply. In the latest University of Michigan Survey, household long-term inflation expectations – expected inflation five years out – surged to the highest level in thirty years in February.

Granted, the direct impact from tariffs and fiscal actions regarding spending and taxes would not hit the economy until late this year and 2026, but indirect effects will happen more quickly – and may already have. Some consumers pushed up purchases of big-ticket goods to beat price hikes linked to tariffs. Those purchases may have boosted overall spending in December, but left a void in January, when retail sales slumped, reinforcing the distortions in the seasonally adjusted data noted earlier. Meanwhile, the increase in inflation expectations may be giving businesses cover to raise prices more than they otherwise might, boosting actual inflation.

Finally, the Federal Reserve has acknowledged that the prospect of higher tariffs is seeping into rate-setting decisions. The decision to pause the rate-cutting campaign had more to do with the ongoing strength in the job market and stubbornly high inflation data. But some officials admit that their subjective thinking of inflation has increased because of the tariffs, and reaffirmed their view that fewer cuts are in the cards than was intended a few months ago. The prospect that interest rates – and hence borrowing costs – are likely to stay higher for longer portends more of a drag on the economy later this year than expected. Slower growth and higher inflation is a combination dreaded by policymakers. The Fed has a dual mandate: to pursue maximum employment and maintain a stable, targeted, inflation rate. Achieving one side of the mandate is hard enough but a policy dealing with both when they are moving in opposite directions has rarely been accomplished without causing a recession. Let’s hope the fog of uncertainty clears up soon so one obstacle in the way of a healthy economy in 2025 is removed.