US economics, inflation, and the Fed

The U.S. economy is slowing down. Several factors, including weakening consumer sentiment amid the ongoing global trade war; inflation still for the most part running above the Federal Reserve’s comfort level; and uncertainty about fiscal and monetary policies, exacerbated by President Trump bickering with Federal Reserve Chairman Jerome Powell over the direction of interest rates, are hurting domestic output. These events have shaken global equity and fixed-income markets and pushed the value of the dollar down versus other currencies, to a three-year low.

The U.S. consumer sector is weakening. True, March retail sales rose a better-than expected 1.4%, but a good portion of the advance was likely driven by shoppers buying ahead of the Trump Administration tariffs. On point, the University of Michigan’s consumer sentiment reading fell to 50.8 in April, marking the second-lowest reading, dating back to 1952. Likewise, The Conference Board’s Consumer Confidence Index fell by 7.2 points in March, to 92.9, the fourth consecutive monthly decline. It also is worth noting that the Expectations Index, which is based on consumers’ short-term outlook for income, business, and labor market conditions, dropped to 65.2, the lowest level in 12 years and well below the threshold of 80 that usually signals a recession ahead according to Value Line.

On top of consumers getting cautious, the housing market also is struggling, as reflected by recent declines in residential construction activity. Specifically, March privately owned housing starts came in at a seasonally adjusted annualized rate of 1.324 million, which was down 11.4% from the prior-month tally.
However, while the near future is clouded with uncertainty, the secular or long-term trends remain firmly in place. In his latest note, Professor Siegel points out:

“Importantly, while tariffs and dollar weakness are stirring short-term concerns, long-term inflation expectations remain firmly anchored, setting a strong case for the Federal Reserve to begin cutting rates.

One of the Fed’s favorite indicators — the 5-year forward inflation rate — is sitting near multi-year lows at 2.3% for CPI, translating to approximately 2% for PCE, exactly at the Fed’s target. Despite political rhetoric around tariffs and inflation, the data tells a clear story: long-term inflation expectations are stable, providing the Fed room to ease without risking a resurgence in inflation. Combined with tepid money supply growth — averaging under 4% compared to a historical norm of 5.5% — there is robust analytical justification for cutting rates…

Looking ahead, the inverted yield curve persists, with the Fed Funds Rate higher than the 10-Year Treasury. Historically, a healthy yield curve slopes upward by about 100 basis points. To normalize, the Fed would need to bring rates down to roughly 3.3%. In my view, the current data environment justifies two to three 25-basis-point cuts by year-end.”

Global economy

Sentiment is sensitive to policy news and there are certain to be more surprises ahead. Market sentiment was boosted lately as the Trump administration signaled progress towards trade agreements with several countries. JP Morgan (JPM) believes it is premature to anticipate a material reduction in the drag from current tariff rates. As the bank highlighted in a recent note, a retreat to 60% tariffs on China and a universal 10% elsewhere would maintain the US average effective tariff rate at a still elevated 16%. This is much larger than JPM’s start-of-year expectations, with an estimated direct impact on global GDP of 0.7%. There is also no evidence that substantive negotiations are taking place with China, the EU or within the USMCA (USA, Mexico, and Canada) that will deliver a quick drop in tariffs with our key partners.

The most likely catalyst for a major reduction in tariff rates JP Morgan thinks would be unilateral détente by the US prompted by recession concerns. While this is a reasonable scenario to consider, the timing of any change is of crucial importance. Once the interacting drags described above advance to the point that US businesses start to retrench, it is not feasible to expect corrective policy announcements to short-circuit a recession dynamic.

While JPM forecasts a recession across North America the bank doesn’t expect a global downturn. Global GDP growth is anticipated to lag its potential pace by roughly 1% over the coming four quarters, falling well short of the 2% gap that has aligned with previous global recessions. The case for divergent outcomes is partly related to expectations of a relatively large US business sentiment shock. But the primary source of projected divergence is the unique US tariff tax hike that will be reflected in relative inflation outcomes and policy easing.

March inflation news does not show inflation divergence. After a broad-based upside surprise in January, core inflation has shown a similar widespread moderation. But tariffs have yet to pass through to US consumer prices. US core CPI is projected to jump to a 6% annual rate for the next two quarters, while inflationary impulses in the rest of the world are likely to be tilted to the downside. A pullback in US goods demand along with a decoupling of US-China trade should put downward pressure on goods prices as excess supply is redirected elsewhere. Absent a meaningful retaliation by other countries, JPM sees core inflation outside the US on a moderating path to below 2.7% annual rate in 2H25, down from 3.2% in 2Q25. Aiding the global disinflation process is a renewed decline in commodity prices. Lower energy prices should help to blunt the purchasing power squeeze on US households from the upcoming tariffs, while supporting consumers globally during a period of heightened uncertainty and softening sentiment.

JPM believes that softening inflation outside the US should lend more flexibility to central banks globally to respond to the fallout from the US tariff shock. What’s more, previous US downturns have tended to generate safe-haven capital flows that restrict EM central banks. While central banks have erred on the cautious side since tariffs were first implemented, delivering only limited cuts despite mounting downside risks to growth, their rhetoric remains dovish. In total, JPM looks for 17 EMs (out of 22 in our GDW universe) and most DM central banks to be easing by year-end.

Despite the short-term turbulence, JPM still forecasts the US and Global GDP to grow by 1% and 2% annually in 2025.

Stock market opportunity

In their latest Market Monitor publication Goldman Sachs states:

“For the long-term investor, periods of volatility and pullbacks typically happen every year, with the average yearly drawdown over the last decade being -13% and lasting about 70 days. Despite these drawdowns, full calendar year returns for the S&P 500 have either been positive or significantly higher, as recoveries tend to occur swiftly after a drawdown. With GIR’s recession probability a close coin flip (45%), we believe investors stand to benefit from portfolios that are built to hedge against risk but are not excluded from potential upside.”

Keep the faith and stay tuned!

The information and opinions included in this document are for background purposes only, are not intended to be full or complete, and should not be viewed as an indication of future results. The information sources used in this letter are: WSJ.com, Jeremy Siegel, Ph.D. (Jeremysiegel.com), Goldman Sachs, J.P. Morgan, Empirical Research Partners, Value Line, BlackRock, Ned Davis Research, First Trust, Citi research, HSBC, and Nuveen.

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