Swagger vs. Lagger: Which One Describes the Near-Term US Growth Outlook?

You can tell whichever story you want right now. But as I read the data, the headwinds dominate.

If you want to make the case that the economy’s doing great, fighting its way through the policy obstacle-course the Trump admin has constructed, it’s not hard to do so. Or, if you want to make the opposite case, you can do that too.

So, which is it? Is the $30 trillion U.S. economy trundling along, unencumbered by the slings and arrows of tariffs, Fed attacks, soaring deficits, etc. or is it stumbling?

BLUF: An increasing spate of data show that the admin’s economic agenda is having negative economic impacts, but they are not yet recession-inducing, and with luck and some trade-war pullback (which we are decidedly not seeing), it may not come to that. But it is likely that we’ll end this year with slower growth, higher unemployment, and higher inflation.

As regular readers know, I put a lot of weight on real consumer spending, and I’ve been underscoring the fact that it has been flat through May (most recent data). We’ll get June spending data next week, but here’s a figure from GS Research wherein they estimate June based on available data, including the above-expectations June retail sales report. They find that real spending was flat in the first half of the year (“H1”).

Here’s what they had to say about that:

Even a one-time price increase will eat into real income, at a time when consumer spending trends already look shaky. Although…retail sales rebounded in June, we estimate that real personal consumption has now stagnated on net for six months, which rarely happens outside of recession. Housing activity has also slowed sharply, with overall construction spending falling faster over the past year than at any time since the post-2008 housing bust. The weakness in consumption and housing has pushed down our tracking estimate for H1 real GDP growth to 1.1%...[w]e expect a similar pace in H2, as the growing real income drag from tariff-related price increases offsets the boost from easier financial conditions.

Growth of 1% isn’t a recession, but it’s typically not fast enough to prevent the unemployment rate from rising. GS adds this point: “…if GDP growth remains sluggish, the labor market might soon hit “stall speed”—a pace of job creation weak enough to trigger a self-reinforcing rise in unemployment.”

The problem we face is that, while the tariff passthrough to consumers is clearly occurring, it’s taking longer than the last Trump trade war (see figure below, also from GS). That’s good for consumers, of course, so why is that “a problem?”

For a few reasons. One, as the red bars above show, consumer passthrough is building, much as we expected, as the buffers against it fade (e.g., pre-tariff-inventory build-up). Second, Trump-world admits to zero passthrough, and have taken advantage of the gradual pace shown in the above figure to ramp up the trade war, with predictable upward pressure on the average tariff rate, which is now close to 20%. Third, the other fading buffer against consumer-price passthrough comes through firms allowing the tariffs to squeeze their profit margins. GM is the most recent poster child:

A few punchlines:

—It is correct to think about growth right now in H1 and H2 terms. GDP growth for Q2, which we’ll also get next week may come in north of 2%, i.e., a healthy growth rate. But just as we discounted the -0.5% real GDP rate for Q1, so should we do so for Q2, as it’s likely to be biased up (due to the normalization of imports, which surged in Q1). So, take an average to get ‘25H1.

—That probably leaves us with ~1% for H1 and based on the discussion above, I agree w GS that H2 could also come in around 1%. This is likely to push the unemployment rate up by the end of the year, probably to around the mid-4’s.

—Given rising passthrough, inflation is also likely to rise by year’s end, delivering the stagflation that we were worrying about when the trade war took shape. If so, that continues to make life hard for the Fed and could constrain forthcoming plans to cut rates.

But if all that’s the case, why are seeing headlines telling us that the “U.S. Economy Is Regaining Its Swagger.” In part, as WSJ Fed reporter Nick Timiraos said yesterday in our Let’s Do Lunch discussion, this assessment is relative to the much darker outlook that took hold in April when Trump launched the trade war.

Also, financial markets, stocks in particular, have been climbing (GS notes the “boost from financial conditions”), though the gains are concentrated in the high-cap tech firms making big bets on AI (see figure). That’s fine—I wouldn’t call this a bubble yet—but it’s too concentrated to do much about the headwinds discussed herein.

We’ll soon see who’s right here, and I hope I’m wrong. But early signs that Trump was looking for tariff off-ramps look less promising now, and I haven’t even raised the cost and interest-rate pressures from the other parts of the agenda, including deportations, the budget bill (which is already pressuring health insurance premiums), and harassing the Fed.

In other words, cracks are forming and I don’t see any forthcoming policy glue to fix them. To the contrary, I see more of the stubborn pursuit of policy that will make them wider.