Challenging a complacent consensus

The following is an extract from our 2025 global outlook.

In 2024, the US economy delivered solid growth, alongside falling inflation and a rebalancing labour market. However, the recent presidential election result could challenge this benign economic environment, in our view.

Donald Trump has won a strong mandate for radical change by winning the popular vote and control of Congress. We’ve heard about his policy plans for deregulation, tax cuts, tariffs and immigration, but we don’t know the timing, magnitude or likelihood of their implementation. Forecasters are making assumptions amid the uncertainty, but so far are sticking with a continuation of the soft-landing narrative and a positive view on US productivity trends.

Three key themes are emerging:

1. Additional tariffs are expected on China, but only for a steady phasing in later in 2025 and 2026.
2. Tariffs outside of China are assumed to be limited, though the risk of a broadening is recognised. Tariffs are seen as raising the price of goods impacted, but this inflation impulse is perceived as temporary. The hit to growth is considered modest and offset by the positive growth effects from deregulation and tax cuts.
3. Forecasters expect the administration to slow the inflow of immigrants, but deportations beyond criminals are considered extremely difficult.

We think the current market consensus is complacent and mistakenly extrapolating the reflationary effects from Trump’s policies during his first administration. Today, the economy is later cycle. Inflation is above, not below, target and the budget deficit much wider. Fiscal policy might not bring the widely hoped-for stimulus, as Congress could look for offsets to pay for extending tax cuts expiring next year. This could involve curbing government spending or rolling back parts of the Inflation Reduction Act, but lawmakers will likely resist any reductions to popular programmes. This means tariffs are potentially an attractive, albeit risky, way for Congress to raise revenues.

Recession risk

Consensus could also be underestimating both the extent of tariffs and the impact for any given tariff level. The experience from the first Trump administration shows that tariffs are largely passed onto consumer prices. So there is a direct squeeze on real incomes and consumer spending. But during his first term, the overall effective tariff rate only rose around two percentage points. If Trump now follows through on previous promises and implements a 60% tariff on China and 10% on the rest of the world, the impact is likely to be eight times larger. It is not clear whether the effect will be linear. The disruption to supply chains, chilling effect on business confidence and investment, as well as potential retaliation and tightening in financial conditions, could interact to conceivably trigger a global recession.

Outside of the US, consensus has some concern around the negative implications of the ‘America First’ policy. China is likely to be most adversely affected, although its reliance on exporting to the US has roughly halved since the first wave of tariffs were introduced in 2018. European growth has been sluggish and fiscal policy is set to turn more restrictive in most countries in the region. It remains to be seen whether Germany will ease the debt brake to address some of its structural challenges.

Finally, we are cautious on the UK. The recent tax-raising budget appears to have dented business confidence and pushed up interest rates, which could offset any growth boost from increased government spending. If the UK gets caught in a global trade war, the Bank of England might need to deliver a faster pace of easing than markets currently anticipate.

The above is an extract from our 2025 global outlook.