The US Economy

Fed Independence

• The biggest source of risk to the US economy is the loss of Federal Reserve independence. Trump said the benchmark federal funds rate should be reduced from its current 4.25-4.5 per cent range to around 1 per cent. What is less clear is whether this represents the firm policy intention of the President, or whether this is just a political distraction, or a way to blame someone else for any pain arising from the new tariffs. If money markets come to the view that the Federal Reserve was not taking sufficient action to bring inflation to target, bond yields would rise in line with long-run inflation expectations (regardless of the Federal Reserve policy rate), and the cost of sustaining the US national debt could increase significantly.

Tariffs

• As at 31 July, Trump has finalised his tariff "deals", with effect from 1 August 2025. Imports from most nations will attract a baseline 10 per cent tariff rate. Many exporter nations will face higher tariffs (up to 30 per cent for China, 15 per cent for Japan and South Korea, for example). [https://www.whitehouse.gov/presidential-actions/2025/07/further-modifying-the-reciprocal-tariff-rates/].

• The negotiation process has been a shakedown. The US announced outsized tariffs on April 2, paused them on April 9, secured some concessions from key nations, then settled on more modest tariffs at the end. There remains a risk of further shakedown rounds in the future.

• The largest downside for the US from its tariff policy is the broad-based nature of the tariffs, particularly their application to intermediate goods. Tariffs on intermediate goods - goods that are inputs to US manufactured goods - make the resulting US manufactured goods less competitive (more expensive) on international markets. The 25 per cent steel and aluminium tariffs are particularly pernicious in this regard. 

• The multi-year inflation risk from tariffs are often over-rated. The imposition of tariffs will increase many prices in the US, but these impacts should be largely transitory. It should be something like the introduction of the ten per cent Goods and Services Tax (GST) in Australia in July 2000. A transitory increase in the headline inflation figure which washes out after 12 months. However, I expect the price impacts to be staggered over 24 months in the US, as exporters and importers initially absorb some of the tariff costs through margin compression for a period of time (in part as they respond to Trump's idiosyncratic policy style). In the long run, I expect US consumers will bear the lion's share of the tariffs.

• The tariffs alone, would see US GDP growth rate weaken. But any slowing should be more than offset by growing US budget and current account deficits. The world should, for a few more years yet, continue to buy US Treasuries, and this should continue to prop up GDP growth in the US.  Of course, the US cannot continue to do this forever. And at some point it will be forced to deal with a budget deficit that is growing faster than GDP growth. 

US national debt

• The US public debt (a little over \$29 trillion in debt held by the public, which excludes intra-governmental debt, and is around 100 per cent of US GDP, with $7.9 trillion in foreign ownership) is getting to a size where it is an increasing source of uncertainty. In the very-long term, the current rate of debt growth is not sustainable. 

Inflation, unemployment and interest rates

• The core CPI inflation rate has been flat over the past few months, and remains above the 2 per cent target. Core CPI came in at 2.9 per cent year-on-year in June 2025 (was 2.8 per cent in May). The core PCE price index in the US, which excludes volatile and energy prices rose by 2.8 per cent year-on-year. It was unchanged from May 2025. Tariffs will see the headline inflation rate remain elevated for longer. 

• While, the US inflation rate will remain elevated for longer, I expect the Federal Reserve will ultimately look through the transitory nature of the tariff based inflation component when it sets the federal funds rate.

• The US labour market is being impacted by countervailing demographic forces, with immigration-based population policy on one side, and slowing jobs growth/demand on the other. The headline statistics remain strong by historical standards, with an unemployment rate of 4.2 per cent (July 2025, up from 4.1 per cent in June). However, jobs growth over past three months has been slow: 73,000 new jobs in July, 14,000 in June and 19,000 in May. 

GDP growth

• Although GDP declined in Q1 (-0.5 per cent Q on Q), this was largely an artefact of how GDP is calculated, and a surge in imports as business and households sought to front-run the foreshadowed tariffs. It rebounded in Q2 (+0.7 per cent Q on Q). Again this result is an artefact, this time in the opposite direction with slowing imports associated with tariffs. Averaging and annualising these two prints, economic growth of around 1 per cent is weaker than the long-run US average (2.0 to 2.5 per cent). 

Recession risks

• Given the weakening US jobs market, the likelihood of a US recession is elevated (say 40 per cent) in the next 12 months (above the naive baseline of 1 recession every ten years on average, over the past 40 years - the COVID-19 recession, the Global Financial Crisis (what the US Americans call the Great Recession), the Dot-Com recession, and the early 1990s recession).

Update

• The release of the revised jobs data on August 1st has changed my perspective on the strength of the US economy, and the likelihood of a recession. The number of new jobs in May and June was revised down by -258,000 jobs in total.