Weak US Economic Outlook Persists Despite Brief Trade Truce

A 90-day truce to temporarily slash steep US-China import duties has marginally reduced US recession risks, but the fiscal outlook is worsening ahead of an imminent vote in Congress on President Donald Trump’s sweeping tax-cut bill following a sovereign credit rating downgrade from Moody’s on Friday.

Economists in a May 14-21 Reuters poll were unanimous the Trump administration’s policies have hurt the economy, with over 55 per cent saying “significantly hurt”.

But after big downgrades to their growth and upgrades to inflation forecasts in April, economists kept these broadly unchanged in May.

“Moody’s is likely sending a message that the proposed tax bill is fiscally profligate… unless there is an abrupt move, the risk is that by the time Washington gets serious about the US’s fiscal problems, tariffs might be the only available lever to meaningfully reduce the deficit,” noted Aditya Bhave, a senior US economist at Bank of America.

“Another round of large tariff hikes would probably be more painful for the economy than a less expansionary fiscal package.”

The economy, which contracted 0.3 per cent last quarter largely due to a record surge in imports, is forecast to grow 1.5 per cent this quarter. It would grow just 1.4 per cent this year, a sharp slowdown from last year’s 2.8 per cent. Next year, it was forecast to expand 1.5 per cent.

The median probability of a US recession over the coming year did, however, decline to 35 per cent from 45 per cent in April.

Economists barely changed their views on inflation, expected to average above the Fed’s 2 per cent target until at least 2027, echoing consumer expectations which are already at a multi-decade high.

“The bad news is the detente virtually locks in a slow growth, sticky inflation environment as the base case for the US economy. The effective tariff rate at 13 per cent is still substantially higher than where it was coming into the year (around 2 per cent)… Policy uncertainty is high and recession risks remain elevated,” said Michael Gapen, chief US economist at Morgan Stanley.

Fed officials have highlighted elevated risks of a resurgence in inflation, primarily due to US tariff policies and appear to be in no hurry to cut rates anytime soon. The federal funds rate has stayed in a 4.25 per cent-4.50 per cent range since the start of this year.

Just over half of economists, 52 of 103, predicted the Federal Open Market Committee (FOMC) would resume cutting its key interest rate next quarter, most likely in September. That was in line with interest rate futures pricing.

A significant minority, 25, expected the reduction in the final quarter and 18 saw no cuts this year. Only eight forecast a June cut, compared to nearly 40 per cent expecting at least one reduction by end-Q2 in the April survey.

There was no clear consensus on where the rate would be by end-2025. But about three-quarters of economists, 74 of 103, predicted it in a 3.75 per cent-4.00 per cent range or higher, a bigger majority compared to two-thirds in April.

“The two pauses (on tariffs) add a new degree of uncertainty to the outlook for both growth and inflation,” said Chris Low, chief economist at FHN Financial.

“FOMC participants insist on seeing all of the inflation directly attributable to tariffs before cutting rates so they might have to wait until the fourth quarter, or even early next year, before they have sufficient clarity to do anything.”

Source: Reuters