U.S. growth could fall sharply in Q1 2025, increasing the potential for a 2025 recession. According to the Atlanta Fed’s GDPNow estimate of Q1 growth, gross domestic product is likely to be -3.7% for Q1 2025 based on economic data available as of April 1. That would represent a significant quarterly decline in growth.
U.S. consumer confidence has recently fallen, while consumer inflation rates remain elevated, with year-on-year inflation rates well above the Fed’s 2% target.
Tariffs present inflationary risks, but tariff uncertainty risks appear to be recessionary. As such, trade and tariff policy uncertainty could also prove deflationary. However, if the Fed is unable to cut interest rates in the face of falling growth, the potential for stagflation would rise.
Ongoing trade and tariff policy uncertainty, as well as forthcoming U.S. tariff announcements, present additional significant risks for the economy and financial markets.
Trade War Adds Recession Risks
U.S. tariff threats and trade policies have been weaponized to advance U.S. geopolitical conflict deterrence and economic statecraft, acting as the sword and shield of economic security to support U.S. self-sufficiency and undercut Chinese economic power.
The Realpolitik driving the Trump administration’s trade and tariff posturing is informed by a containment doctrine to mitigate the propensity for Chinese manufacturing and exports to undercut U.S. and North American heavy industry.
Recession And Stagflation Prospects
A recession occurs when U.S. GDP contracts, the labor market weakens, and business slows. Prices and inflation also usually fall during a recession as consumer demand falls.
On the other hand, stagflation is a period when growth is weak and inflation is elevated. In the 1970s, stagflation was a mix of deep recession and double-digit inflation.
U.S. consumer confidence weakened significantly in February and March, weighing on the U.S. growth outlook. However, consumer inflation also remains elevated.
In recent quarters, the strong U.S. labor market has been the most important factor supporting economic growth. In February, the U.S. economy had a record-high level of total payrolls at 159.2 million, a very high level of job openings at almost 7.6 million, and a relatively low unemployment rate of 4.1%.
Elevated Inflation Could Prevent The Fed From Countering A Recession With Rate Cuts
As recession risks increase, the Fed is usually motivated to cut interest rates. However, elevated consumer inflation rates could hinder the Fed from cutting interest rates, thereby increasing stagflation risks. U.S. year-on-year consumer inflation rates are elevated and well above the Fed’s 2% target.
February year-on-year Consumer Price Index inflation rates were 2.8% for the total CPI and 3.1% for the core CPI. The total Personal Consumption Expenditures inflation rate was 2.5% for the total PCE and 2.8% for the core PCE. Total year-on-year CPI and PCE consumer inflation rates are likely to fall close to the Fed’s 2% target in 2025.
While FOMC projections imply only two rate cuts in 2025, we expect three 0.25% rate cuts. Plus, even more cuts are likely if inflation or growth slows. Prestige Economics expects the next Fed rate cut on June 18. Additionally, the CME FedWatch Tool and the odds of a June 18 Fed rate cut of at least 0.25% were 71.4% as of April 1 at 8:53 p.m. ET.
Weak Consumer Confidence And Sentiment Increase Recession Risks
Over 69% of GDP growth in Q4 2024 was personal consumption. It’s why falling consumer confidence and sentiment increase the odds of a U.S. recession.
In the Conference Board’s Consumer Confidence Index, the present situation and expectations series fell in March. The headline index fell to 92.9 from 100.1 in February. Meanwhile, the present situation series fell to 134.5 from 138.1 in February. However, the expectation series fell sharply to 65.2 from 74.8 in February.
Most importantly, the expectations series is now at the lowest level in 12 years and below 80, which is often a signal of a potential future recession. The deterioration of this series has been rapid since the expectations series was 93.7 in November.
Meanwhile, the final March University of Michigan Index of Consumer Sentiment fell to 57 from 64.7 in February. The outlook series had a more significant impact on the decline in the headline consumer sentiment series since the outlook fell sharply to 52.6 from 64 in February, while the present series fell more modestly to 63.8 from 65.7.
As a further sign of concern, the forward-looking Institute for Supply Management Manufacturing Index declined in March 2025 to 49 from 50.3 in February, underscoring the potential for a contraction in Q1 2025.
Trade Policy Uncertainty Adds To Recession And Stagflation Risks
Falling consumer confidence and the prospects of falling growth present recession risks that would negatively impact the economy, the labor market, and financial markets. Meanwhile, the concomitant manifestation of elevated year-on-year inflation rates reveals significant stagflation risks, which would be the worst of both worlds for the U.S. economy and the future of Fed policy.
The Fed is poised to cut interest rates, especially if inflation eases and payroll gains slow.
If tariff risks remain elevated, the Fed may need to cut rates significantly more than is currently priced into financial markets. However, if growth slows but inflation remains elevated, the Fed may struggle to implement more accommodative monetary policies to support confidence and buttress growth.
Tariff risks present the most significant downside potential for financial markets, which means forthcoming U.S. tariff announcements could add to the threat of stagflation or recession.