Mark Vitner

The implementation of larger-than-expected tariffs in 2025 has significantly altered the economic landscape, leading both the Federal Reserve and private forecasters to sharply revise downward their projections for U.S. economic growth. The tariffs, which are broader and more enduring than initially anticipated, are expected to disrupt both U.S. and global economic growth. The cumulative effect of all tariffs enacted in 2025 is projected to reduce U.S. real GDP growth by 1.5 percentage points in 2025 from what it otherwise would have been.

The moderation in growth is due to heightened uncertainty surrounding tariffs, which reduces hiring and business fixed investment, and slower real income growth, resulting from weaker job growth and higher prices. Moreover, the front-loading of imports ahead of tariffs will result in wide swings in real GDP growth, further fueling uncertainty and increasing the risk of a policy mistake. Following the pandemic, economic growth has shown a tendency to come below expectations during the first half of the year, including a decline in the first quarter of 2022 followed by a scant 0.3% rise the following quarter.

The latest wave of tariffs has pushed the average effective tariff rate to 22.5% — the highest since 1909 — amplifying price pressures on imported goods and adding fuel to broader inflation risks. The larger-than-expected scope of the tariffs triggered a front-loading of shipments ahead of implementation, driving up import prices and signaling further price increases in the pipeline. The inflationary impact is expected to weigh heavily on household budgets. The Yale Budget Lab estimates tariffs will cost U.S. consumers an average of $3,800 per household, with middle- and lower-income families bearing a disproportionate share of the burden.

Globally, escalating tariffs have triggered a wave of retaliatory measures, further deepening uncertainty around the economic outlook. China, for example, has raised its retaliatory tariffs on U.S. imports to as high as 125% and suspended exports of critical minerals and magnets — a move that threatens to further strain global supply chains. Several other trading partners have followed suit, either threatening or enacting countermeasures of their own, pushing the global economy closer to a broad-based trade war.

The International Monetary Fund highlighted the growing risks from prolonged trade tensions, estimating a universal 10% increase in U.S. tariffs — accompanied by full retaliation — could cut U.S. GDP by roughly 1% and global GDP by 0.5% through 2026. The IMF also warned that the indirect effects on business sentiment and investment could compound these losses, especially if tariffs remain in place or expand further.

Federal Reserve Chair Jerome Powell stated similar concerns, noting persistent trade policy uncertainty has become “a notable headwind” for both U.S. and global growth. Powell specifically flagged the disruption to supply chains and the rising cost of intermediate goods as critical channels through which tariffs are now impacting decision-making. His remarks echoed the findings of the First Quarter 2025 CFO Survey, which showed over 30% of firms citing trade and tariffs as their top concern, highlighting a growing fear that production costs will continue to climb, and strategic investment will be deferred as long as trade tensions remain unresolved.

.

The strained relationship between President Donald Trump and Federal Reserve Chair Jerome Powell has become an increasingly destabilizing force in the 2025 economic landscape. The feud has escalated well beyond a political drama to a real threat toward the Fed’s independence and credibility. With tariffs driving inflation higher and growth slowing, the widening gap between the White House’s push for rate cuts and the Fed’s cautious stance is adding to market uncertainty.

A core principle of monetary policy is to ensure price stability — famously defined by Alan Greenspan as an environment where inflation is no longer a factor in business decisions. Yet the Fed’s dual mandate also obliges it to support full employment, placing Powell in a difficult balancing act as tariff-driven price pressures mount.

Trump intensified his attacks on Powell, stating his “termination cannot come fast enough” and accusing the Fed of “playing politics” by not cutting rates. Powell has signaled no intention of stepping down before his term ends in May 2026, reaffirming the Fed’s commitment to price stability over politically expedient easing.

At the core of the standoff is a fundamental policy divide. Trump is seeking rate cuts to cushion the impact of his trade agenda, while Powell remains wary of repeating the Fed’s 2021–2022 misstep of underestimating inflation risks, particularly related to supply chain risks. Speaking in Chicago, Powell warned tariffs were “highly likely” to trigger at least a temporary inflation spike, with the potential for more persistent effects if costs pass-throughs proves stickier than expected.

Markets have started to price-in political risk. Betting platforms now place the odds of Powell leaving before year-end at roughly 25% — nearly double from a month ago — as investors recalibrate expectations for both Fed policy and the broader stability of U.S. economic governance.

Powell’s removal remains unlikely given the legal and institutional hurdles. Trump’s sharp rhetoric appears aimed less at undermining Fed independence and more at shifting blame should the economy slip into recession from the trade war. Even if Powell were replaced — with Kevin Warsh rumored as a frontrunner — markets expect little immediate change in policy. The broader risk, however, is clear: a more politicized Fed only deepens the challenges of navigating a fragile economy, where fiscal and monetary authorities are increasingly at odds and more likely to make a mistake. Such an environment would further fuel financial market volatility. Asset prices would fall given the higher perceived risks that would be present in the U.S. and global economies.

Financial markets responded harshly to the introduction of tariffs. Global equities tumbled in early April, with the S&P 500 falling nearly 5% on April 3 — its steepest single-day drop since June 2020 — and the Nasdaq sliding roughly 6%. Gold prices surged, Treasury yields initially dipped on risk-off flows, and the Chinese yuan sank to a seven-week low. Crude oil prices also retreated on fears of slowing global growth. Stock markets have since rebounded, after some tariffs were later delayed but bond yields have only fallen back modestly.

The absence of a traditional “flight to safety” following the early April tariff announcements has sharpened doubts about U.S. exceptionalism and the dollar’s role as the world’s reserve currency. Markets appear to be pricing in not only the immediate trade disruptions but also deeper structural risks — including shifting global production patterns and intensifying competition for capital — reminiscent of the environment that existed prior to to the late-1990s Asian Financial Crisis (1997) and Russia Debt default (1998) which led to the collapse of Long-Term Capital Management (LTCM) and a flight to safety to U.S. dollar assets. The influx of global savings drove U.S. interest rates down and fueled bubbles in tech stocks, housing, and other assets.

Today, a weaker dollar and rising Treasury yields suggest investors are bracing for lasting economic dislocations rather than a short-lived trade skirmish. Higher yields also reflect expectations of reduced foreign demand for Treasuries, as Trump’s tariff strategy aims to narrow the U.S. trade deficit, and capital reallocates toward emerging markets poised to absorb displaced production. Prior to the collapse of LTCM, the yield on the 10-Year Treasury Note consistently remained above nominal GDP growth – which would put it over 5.0% today.

Geopolitical tensions remain elevated, compounding concerns over U.S. leadership. Russia continues to exploit perceived U.S. foreign policy divisions, rejecting ceasefire overtures while regaining all Ukrainian-held territory in the Kursk region. Rising Ukrainian casualties and stalled diplomacy suggest Moscow is using negotiation talk to consolidate further gains.

In the Middle East, U.S. airstrikes on Houthi targets have escalated, yet Red Sea shipping disruptions persist. Meanwhile, Iran shows no signs of moderating its nuclear ambitions, raising the risk of broader regional conflict.

Economic and geopolitical stress points are converging in a rare and destabilizing fashion. While the U.S. dollar remains the global reserve currency by default, its primacy is being tested. Gold has emerged as a relative safe haven, outperforming Bitcoin and other crypto assets in the current crisis environment.

.

One of the clearest byproducts of tariff-driven uncertainty is the widening gap between soft and hard economic data. The divergence appears rooted in the Trump Administration’s shifting — and at times contradictory — tariff strategy. Multiple rounds of tariffs have been introduced, each with differing and sometimes overlapping objectives, leaving businesses and households to navigate an unusually opaque policy landscape.

Some tariffs have been explicitly framed as tools to curb the flow of illicit fentanyl, targeting specific chemical imports and manufacturers in China and Mexico. Others are aimed at what the administration describes as “unfair” trade practices, designed to shield U.S. manufacturers from subsidized foreign competition, particularly in heavy industry and advanced technology. A third category of tariffs appears driven by fiscal objectives — boosting government revenues to help finance a restructuring of the U.S. tax system.

For markets, businesses, and consumers alike, the mix of motives — economic, geopolitical, and fiscal — makes it exceptionally difficult to discern which tariffs are intended as short-term negotiating levers and which are likely to become permanent fixtures of U.S. trade policy. One question repeatedly raised across boardrooms and trading desks is: “Where’s the off-ramp?” That uncertainty has weighed heavily on sentiment, forcing many firms to slow hiring, delay investment, and shift their focus toward short-term risk management — a dynamic reflected in the persistent weakness across business and consumer surveys, including the NFIB Small Business Optimism Index, ISM PMIs, and the Conference Board’s Consumer Confidence Index.

The tariff uncertainty is also distorting business activity in real time. Firms are stockpiling inventories ahead of scheduled tariff increases, diverting time and capital away from growth initiatives. Consumers, too, are adjusting their behavior, pulling forward big-ticket purchases — particularly for new and used vehicles and large appliances — on expectations that prices will climb once tariffs take effect.

Tariffs, and the threat of tariffs, are being used to meet multiple objectives and the process has been messy. Until it becomes clearer how much of the tariffs are a temporary bargaining tool and how much marks a permanent shift in U.S. trade policy, the gap between soft and hard economic data is likely to persist. Businesses are already pricing in this risk, even as consumers continue to spend. But the longer the uncertainty drags on, the greater the odds that caution will spill over into actual hiring, investment, and growth.

Trump’s aggressive tariffs have clouded the outlook, pushing inflation expectations higher while placing downward pressure on real income and business investment. While recession risks remain elevated, current labor market trends and resilient consumer spending suggest a narrow path to avoiding a full-blown contraction still exists. That path, however, hinges on a meaningful de-escalation of trade tensions. After teetering on the edge of a global trade war, recent developments suggest a tentative step back from the brink.

The bulk of the most recent hard data show the economy continuing to grow modestly. Consumer spending surprised to the upside in March, supported by lower gasoline prices and solid outlays on motor vehicles, furniture, and household appliances. In addition, the production and shipment of commercial and defense aircraft picked up, likely boosting Q1 equipment investment.

Despite this strength, Q1 real GDP growth is expected to be tepid, with most forecasts, including ours, hovering near zero, with risks stacked to the downside depending on how the Bureau of Economic Analysis (BEA) estimates data not yet available. At best, the economy appears to be skirting the edge of recession, and we expect that fragility to become increasingly visible in the employment and income data.

The ongoing public feud between President Trump and Federal Reserve Chair Jerome Powell may complicate efforts to ease rates, particularly in the lead-up to the summer. Nevertheless, we continue to expect a 25-basis-point rate cut in June. Labor market softening—likely to show up in claims and payrolls data ahead of the June 14 FOMC meeting—should provide the necessary pretext. Inflation is likely to remain elevated but broadly in line with expectations. The Fed has room to ease policy, and even three quarter-point cuts would leave the federal funds rate in restrictive territory relative to trend nominal GDP growth and neutral funds rate estimates.

The March Federal Open Market Committee (FOMC) meeting reaffirmed the Federal Reserve’s cautious, data-dependent approach, holding the federal funds rate steady at 4.25%-4.5% while slowing the pace of quantitative tightening (QT). The Fed also announced the runoff of maturing Treasury securities will decline from $25 billion to $5 billion per month, while mortgage-backed securities runoff remains at $35 billion. This adjustment reflects the Fed’s intent to maintain ample liquidity while navigating evolving economic risks. With growth moderating and inflation proving more persistent, the FOMC remains comfortable waiting to assess the full impact of recent and upcoming policy shifts before making further adjustments.

The Fed’s updated Summary of Economic Projections (SEP) suggests a more stagflationary outlook. The 2025 GDP growth forecast was downgraded to 1.7% from 2.1%, while core PCE inflation expectations rose to 2.8% from 2.5%. Despite the median dot plot continuing to signal two 25-basis-point rate cuts in 2025, a growing number of FOMC participants now see fewer cuts, with eight members expecting less than 50 basis points of easing. Chairman Powell acknowledged the rise in short-term inflation expectations, particularly in response to tariffs, but emphasized that a hawkish pivot would require a broader and sustained unanchoring of long-term inflation expectations. While the University of Michigan’s measure of long-term inflation expectations has increased, Powell downplayed its significance, noting that other indicators remain stable.

Financial markets responded positively to the Fed’s measured approach, with the 10-year Treasury yield initially declining by 10 basis points and equities rallying. The financial market’s improved post-meeting tone has carried over, even amidst continued volatility on various tariff proposals. The decision to slow QT is expected to provide additional support to the economy, particularly by keeping long-term yields in check, which may offer relief to the housing market as it enters the spring selling season.

The Fed may be underestimating labor market risks, as hiring trends point to a weakening job market. QCEW data suggests employment growth through last September was overstated by about 550,000 jobs. If payrolls decline further and unemployment exceeds 4.4%, the Fed might be forced into more aggressive rate cuts. However, persistent inflation—especially from tariffs—may constrain policy flexibility and delay easing until late this year or even 2026. While some compare the Fed’s updated outlook to the 1970s stagflation, those fears seem overstated. Even with slower growth, unemployment is expected to peak at 4.5%, and inflation should remain below 3%, both close to the Fed’s long-run objectives and far from the crisis levels of that earlier era.

We continue to believe that full-fledged stagflation is unlikely. For stagflation to take hold, inflation would need to rise at least one percentage point above the Fed’s 2% target and either persist or show signs of further acceleration, while unemployment would have to rise a full percentage point above the Fed’s full-employment threshold of 4.3% and remain elevated or continue increasing. This sets the minimum stagflation threshold at 8.3%. Current conditions are still well below that level, with inflation at 2.8% and unemployment at 4.1%, which is still below the full-employment threshold. Additionally, solid productivity growth is helping contain inflationary pressures and preventing a wage-price spiral.

The Misery Index, which combines inflation and unemployment, provides a useful gauge of stagflation risk. At 6.9%, it is still well below the 8.3% threshold. Even with our forecast of unemployment rising to 4.4% and core PCE inflation reaching 3.0% by year-end, the Misery Index would only rise to 7.4%. By contrast, during the stagflationary periods of the 1970s and early 1980s, the Misery Index routinely exceeded the high teens due to exceptionally loose monetary policy and major demographic shifts, particularly the influx of baby boomers and women into the workforce. Today’s inflationary pressures stem from more temporary factors—tariffs, supply chain disruptions, and fading pandemic stimulus.

If stagflation risks were to rise, the Fed would face a difficult choice: tighten monetary policy aggressively to control inflation at the cost of higher unemployment and a potential recession or tolerate higher inflation at the risk of unanchoring inflation expectations. Historical precedent favors decisive action, implying higher interest rates. If the Fed were to allow inflation to persist, the eventual costs of bringing it back down would likely be higher. Fortunately, today’s environment is different. Inflation expectations remain well-anchored, and the Fed’s measured approach to rate cuts reflects its strategy to balance inflation risks with risks to the labor market.

Given current conditions, we expect the Fed to maintain policy flexibility—responding as needed to prevent a temporary rise in inflation from becoming entrenched while standing ready to ease if labor market conditions deteriorate. This underpins the Fed’s pause in lowering interest rates. The next move is still more likely to be a rate cut rather than a hike, but the timing has become less certain, with financial markets still expecting two quarter-point cuts this year, albeit with less conviction than before.

Retail sales experienced a significant decline in January, with the headline figure contracting by 0.9% alongside a broad-based pullback across key categories. While adverse weather and seasonal adjustment factors played a role in the reduction, the widespread weakness indicates a softer start to Q1 consumer spending. A major contributing factor was the downturn in auto sales, while discretionary categories—such as sporting goods, furniture, and building materials—witnessed the steepest declines. Additionally, non-store retail sales, primarily online, decreased, prompting questions about whether weather alone was responsible for January’s weakness.

Consumer sentiment has continued to deteriorate in early February, reflecting increasing policy uncertainty. With excess savings largely exhausted, current spending relies more on employment and income growth. Elevated grocery prices and rising insurance costs are likely significant contributors to the decline in sentiment. Consumers’ assessment of current conditions has dropped 6.4 points since December to 68.7, while expectations for future economic conditions—which have a closer link to actual spending—have fallen by 6.0 points to 67.3.

The University of Michigan’s consumer sentiment survey highlights particular weakness among lower-income households. Sentiment for the lowest income tercile has decreased to 64, matching the levels seen during the depths of the Global Financial Crisis. Middle-income households are only slightly more optimistic, with sentiment at 71.3. These figures suggest that economic uncertainty and rising costs are disproportionately affecting consumers with tighter budgets, posing a potential obstacle to discretionary spending.

Despite these concerns, underlying fundamentals support consumer spending in 2025. The unemployment rate remains low at 4%, and weekly jobless claims are near historic lows. Wage growth is robust, and household balance sheets—along with slightly lower interest rates compared to a year ago—should provide some support. Low-rate financing incentives are expected to sustain light vehicle sales and big-ticket spending.

However, financial strength is not evenly distributed across income groups. Rising costs for necessities are disproportionately impacting lower- and middle-income households, putting pressure on discretionary spending. Given these dynamics, we have slightly reduced our estimate for Q1 consumer spending and continue to anticipate a below-consensus gain of just under a 2% annual rate.

Concerns over tariffs’ impact on consumer prices have driven a sharp rise in inflation expectations. The University of Michigan’s Consumer Sentiment Survey showed one-year inflation expectations climbing 0.6 percentage points to 4.90% in March, while five-year expectations rose 0.4 points to 3.90%. Since the end of last year, one-year expectations have surged 2.1 points, and five-to-ten-year expectations have increased 0.9 points. Meanwhile, market-based measures, such as the five-year, five-year forward inflation breakeven, have remained stable, even edging down from 2.24% to 2.12% over the same period.

Federal Reserve officials, including Chair Jerome Powell, have acknowledged this divergence but prioritize market-based indicators. At his March 19, 2025, FOMC press conference, Powell dismissed the University of Michigan survey as an “outlier,” emphasizing that long-term inflation expectations remain well-anchored. The Fed views the inflationary impact of tariffs as a one-time shock rather than a sustained driver of inflation, reinforcing confidence that inflationary pressures will stay contained despite short-term consumer concerns.

The gap between consumer inflation expectations and market forecasts likely stems from an information disparity. Many consumers assume tariffs apply to retail prices, but they are actually levied on the lower imported value of goods, excluding transportation, insurance, and financing costs. This significantly reduces their direct impact on prices. For clothing for example, the imported value is typically just 10% of the retail price. Financial markets, which are better informed on these intricacies, expect tariffs to raise prices in the short term but also slow economic growth, leading to lower inflation over time.

Our view is more nuanced. Trump’s tariff initiative is larger and more variable than expected. We foresee a slightly greater near-term inflationary impact, as businesses preemptively raise prices to cushion against rising costs. This could be worse than the financial markets and the Fed anticipate, particularly for automobiles, computers, and consumer electronics, where the imported value comprises a larger share of retail prices. Supply disruptions may further raise operating costs, which would be passed on to consumers. Additionally, the wave of tariff-related news effectively provides businesses cover to raise prices more easily.

President Trump’s recent executive order imposes a 25% tariff on imported light vehicles starting April 3, 2025, with key auto parts following by May 3 and all parts within 90 days. While vehicles and components under the USMCA receive partial exemptions, tariffs still apply to non-U.S. content. As a result, the effective U.S. tariff rate will rise by approximately 2.5 percentage points by July, with some non-USMCA imports facing tariffs as high as 50%. Reciprocal tariffs set to take effect on April 2 could complicate the impact.

The Administration justifies the move on national security grounds and the need to bolster domestic manufacturing. The White House highlights a $93.5 billion auto parts trade deficit in 2024 and a shrinking industry workforce. By raising import costs, the policy aims to push consumers toward American-made vehicles and incentivize domestic production. A study cited by the administration suggests a global 10% tariff could significantly boost the U.S. economy and employment. There is some room to boost output. The Fed’s latest data show the U.S. auto industry operating at 68.4% of capacity, compared to a historical average of 74.9%. While domestic production should theoretically rise, the broader economic impact remains uncertain. The iron and steel industry is operating at 70.6% of capacity versus an historic average of around 78%.

Higher vehicle prices will likely burden consumers, as the average new car now costs nearly $50,000. Affordability concerns are at a multi-decade high, with automobiles—both new and used—out of reach for a historically large share of U.S. consumers. Automakers like Ford and General Motors, reliant on international supply chains, will likely face higher costs. Meanwhile, major trading partners such as China, Japan, and Germany may impose retaliatory tariffs, further complicating the outlook.

Tariffs align with Trump’s broader economic nationalism, echoing tariffs on steel, aluminum, and Chinese goods during his first term. The auto industry’s economic and symbolic significance makes it central to his trade strategy. However, complexities surrounding exemptions, administrative burdens, and retaliation risks create uncertainty about long-term effects on the U.S. economy and global trade.

Trump’s ultimate goal is unclear—whether to raise revenue, boost domestic manufacturing, or ultimately reshape the global trading system with lower and more transparent trade barriers. The likely outcome is a mix of these objectives. We expect the tariff battle to be largely contained to 2025, with the administration working to minimize economic disruptions ahead of the 2026 midterm elections.

The Trump Administration’s aggressive tariff policies have clouded the economic outlook. Businesses have accelerated imports ahead of tariff implementation, sharply widening the trade deficit and weighing on first-quarter GDP growth. The extent of the drag depends on how quickly these imports move into inventories or reach end users, both of which contribute to GDP. While Q1 output may decline, final domestic demand remains positive, and any shortfall from front-loaded imports should reverse in later quarters, boosting growth.

Beyond trade volatility, the broader economy has also lost momentum. We estimate job growth has been overstated by roughly 550,000 over the past year, with hiring also heavily concentrated in health care, social services, leisure and hospitality, and state and local government. With heightened uncertainty, hiring is expected to slow this spring and summer. However, tighter border enforcement has significantly curbed immigration and labor force growth, limiting any upward pressure on the unemployment rate.

Business investment is a bright spot. Shipments of nondefense capital goods have risen solidly in Q1, driven by equipment for new plants constructed under the Inflation Reduction Act and CHIPS Act. Additionally, commercial aircraft shipments have surged as Boeing works through its backlog.

Our outlook remains cautious, with real GDP projected to grow 1.6% in 2025. However, strong late-2024 growth should lift the annual average to 2.1%. Risks remain skewed to the downside, as the Administration prioritizes early wins on trade and tax reform at the expense of short-term economic disruptions. We expect the Federal Reserve to cut rates twice this year, with the first cut possibly as early as June.