The US economy is heading into 2025 with strong momentum, but significant uncertainties could alter its trajectory.
A strong 3% GDP growth rate in 2024 and the addition of nearly 2 million jobs have defied predictions of a slowdown.
Many were once again left anticipating a recession that never came. Consumer spending and a resilient labour market have kept the economy steady.
However, the upcoming presidency of Donald Trump, set to begin in January, is expected to bring significant policy changes that could alter this outlook.
Trade dynamics, fiscal adjustments, and geopolitical tensions are just a few of the variables that could influence the economic path forward.
Growth will slow, but not stop
The consensus among economists is that the economy will grow at a slower pace in 2025, likely around 2%.
This rate aligns with the long-term potential of the US economy. While soft landings are rare, the Federal Reserve’s recent monetary easing and consumer strength have built a solid foundation for continued growth.
However, factors such as higher interest rates, rising debt levels, and geopolitical risks could act as headwinds.
What will the US Fed do next?
The Federal Reserve reduced interest rates three times in second half of 2024, lowering the terminal rate to 3%.
Markets anticipate fewer cuts in 2025 as Fed Chair Jerome Powell focuses on maintaining stability.
Inflation, currently at 2.4%, is near the Fed’s 2% target but could rise from here. Economists warn that additional tariffs or supply chain disruptions may push inflation higher.
A surprise rebound in inflation could lead to renewed rate hikes, raising borrowing costs for businesses and consumers. For now, markets expect the Fed to tread cautiously, balancing growth and inflation concerns.
Meanwhile, businesses are closely watching the Fed’s actions to plan for capital investment and borrowing decisions.
Persistent inflation above 2% could also impact consumer confidence, potentially slowing the spending that has driven much of the recent economic expansion.
Will consumers remain unfazed?
Real income growth has been a key driver of consumer spending. Unemployment rose slightly to 4.2% by the end of 2024, but hiring remains steady.
Employers are hesitant to lay off workers, a trend known as labor hoarding, which helps stabilize the job market. Despite these positives, elevated consumer debt levels signal financial stress for some households.
Retailers are likely to see mixed results. High-income households may continue spending, but those in lower-income brackets could pull back.
Inflation’s trajectory will play a crucial role in shaping consumer behavior in 2025. Rising costs in essentials such as food and energy could disproportionately affect lower-income families, adding pressure to adjust discretionary spending.
On the other hand, continued real wage growth could mitigate these effects and sustain overall consumption levels.
Policies that could shake things up
The incoming Trump administration’s economic policies are creating uncertainties. Key proposals include new tariffs, tax cuts, and stricter immigration rules.
Analysts expect a 90% likelihood of sweeping tariffs on imports from key trade partners like China, Mexico, and Canada.
Historical data shows a 1% tariff increase raises inflation by 0.1%, potentially offsetting recent progress in price stability.
Proposed tax cuts could boost corporate and household spending but may widen the budget deficit, which is projected to grow by $4.6 trillion if current policies are extended, according to the Congressional Budget Office.
Stricter immigration policies could exacerbate labor shortages, raising costs in sectors like construction and agriculture.
The combination of these policies may create ripple effects throughout the economy. For example, increased tariffs could lead to higher costs for manufacturers and retailers, ultimately passing those costs onto consumers.
Tax cuts, while potentially stimulating short-term growth, may reduce funding for government programs or lead to increased borrowing.
Global tensions add uncertainty
The geopolitical landscape is anything but certain. Lots of ups and downs were observed in 2024 and the next year isn’t likely to be any different.
Revisionist powers like China and Russia are challenging the existing world order.
Xi Jinping’s government continues to focus on Taiwan, raising tensions in Asia.
A perceived decline in U.S. global influence could embolden China to act more aggressively.
Despite economic isolation, Putin remains committed to his vision of restoring Russian influence, particularly in Ukraine.
The U.S.’s trade and security commitments could be tested if these tensions escalate.
America’s “America First” policies may strain alliances and disrupt global trade flows, adding another layer of risk to the 2025 economic outlook.
Businesses with global supply chains may face challenges as they navigate shifting trade policies and geopolitical instability.
Meanwhile, increased defense spending in response to global tensions could provide a boost to certain industries, offsetting some of the broader economic risks.
Is the stock market overvalued?
US equity markets soared in 2024, with the S&P 500 delivering a 29% total return. Technology stocks once again led the rally, driven by advances in artificial intelligence.
However, valuations are now stretched based on historical standards, with the S&P 500 trading at a forward P/E ratio of 22. Nevertheless, elevated profit margins and robust earnings growth are supporting these valuations.
But any earnings disappointments, particularly in tech, could trigger a correction. Case in point, Nvidia’s third-quarter results in 2024 led to a 10% drop in its stock price due to unmet expectations.
For 2025, sector rotation and a closer look at other countries which are now trading at a discount in comparison to the U.S. are becoming favored strategies by experienced portfolio managers.
Are bonds cool again?
With 10-year Treasury yields at 4.6%, bonds now offer reasonable risk-adjusted returns. Long-term inflation expectations of 2.3% suggest that real yields remain attractive for conservative investors. Bonds are also regaining their role as a hedge against stock market volatility.
Corporate debt levels will remain a concern in 2025, particularly in rate-sensitive sectors like housing and utilities. However, strong earnings and productivity gains provide some buffer.
A year to watch closely
The US economy is entering 2025 with solid footing but faces significant risks.
Policymakers must balance sustainable growth with inflation control, while investors are still enjoying the market’s gains over the past few years.
Resilient consumer spending, stable corporate earnings, and moderated inflation will be critical factors in determining whether the economy can maintain its current momentum
The key question remains: can resilience outpace the challenges? If there’s one economy that can, that is certainly the American economy.
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