While the outlook still remains positive, tariffs and inflation could trigger a U.S. recession
The U.S. economy was on relatively solid footing heading into 2025, but an ongoing trade war and renewed stagflation fears have shaken up the economic outlook.
The Federal Open Market Committee (FOMC)’s latest long-term economic projections from March still suggest a soft landing for the U.S. economy that includes slowing GDP growth but no recession. That being said, President Donald Trump has implemented bold and controversial policy measures, making the next several months a critical period for the economy. Labor market conditions have remained resilient up to this point, but U.S. GDP growth dropped into negative territory in the first quarter. The Federal Reserve has also paused its interest rate cuts and is facing a difficult balancing act moving forward.
Economic recessions are no reason for panic and have been a regular occurrence over the past century, but investors can make the most of a difficult situation by knowing which risk factors to watch and how to position their portfolios if a recession strikes in 2025:
2025 Recession Risk Factors
Many factors can trigger or contribute to a recession, but a couple of specific issues are likely the biggest risks to economic stability in 2025: tariffs and inflation.
In the first half of the year, Trump implemented and threatened to implement aggressive tariffs on goods imported from China and other U.S. trade partners around the world, making tariffs a central part of his economic plan.
In early April, Trump implemented a 10% baseline tariff on almost all goods imported to the U.S. and custom tariffs on countries the White House deemed the “worst offenders” on trade. Just days later, Trump announced he would delay most of these new custom tariffs by 90 days. Then on July 7, Trump released updated “reciprocal” tariff rates as high as 40% on more than a dozen countries and said they are set to go into effect on Aug. 1 if the U.S. is unable to reach trade deals with the countries before the deadline. Trump has also imposed or threatened to impose even higher tariffs on specific materials and products, including copper, steel, aluminum, automobiles and pharmaceuticals.
Not surprisingly, U.S. trade partners have retaliated by issuing their own tariffs on U.S. exports. Trump targeted China with a 145% tariff rate, to which China responded by raising tariffs on U.S. goods to 125%. In May, China and the U.S. reached an agreement to lower U.S. tariffs on Chinese goods to 30% and Chinese tariffs on U.S. goods to 10%.
Trump has been extremely fluid in his trade war policies, implementing, delaying and threatening new tariffs on an almost weekly basis as other nations react. When businesses and consumers are unsure about policies surrounding taxes, tariffs and geopolitical conflicts, they tend to delay and reduce spending and investment until they have a clearer outlook.
Supporters of Trump’s tariff strategy say it will help U.S. businesses compete with lower-cost imported products and encourage American companies to hire U.S. workers and choose to manufacture goods domestically. Critics argue tariffs will force U.S. companies to pay higher prices for imported goods and components, and many of these companies will simply pass on those higher costs to consumers by raising prices. Widespread price hikes could be a nightmare scenario for an economy that is already dealing with elevated inflation.
The Federal Reserve has made significant progress in bringing down inflation, but the latest core personal consumption expenditures (PCE) price index reading in late June suggests inflation remains elevated. Core PCE, which excludes volatile food and energy prices and is the Fed’s preferred inflation measure, was up 2.7% year over year in May, above the FOMC’s 2% target.
In its latest long-term economic projections in June, the FOMC called for only two 25-basis-point rate cuts in 2025, bringing the fed funds target range down to between 3.75% and 4% entering 2026. The bond market continues to expect that the FOMC will cut rates at least two times by the end of 2025.