The fundamentals of the U.S. economy are in good shape, with low unemployment and robust growth in recent quarters.
But warning signs have been flashing and markets have been sliding amid policy uncertainties and some troubling macroeconomic indicators.
Here’s a look at the risk factors currently facing the U.S. economy.
Inflation risks
After rising to a 9-percent annual increase in the aftermath of the pandemic, inflation sank nearly all the way back down to the Federal Reserve’s target rate of 2 percent by the middle of last year.
However, it started to rise again through the fourth quarter and the consumer price index (CPI) was back up at a 3-percent increase in January, prompting President Trump to declare that “inflation is back.”
February CPI released Wednesday broke this trend, dipping back down to a 2.8 percent rise, leading many economists to breathe a sigh of relief. The personal consumption expenditures (PCE) price index also fell back in its latest reading, easing from a 2.6 percent rise in December to 2.5 percent in January.
“Today’s more benign CPI reading is welcome news but largely a function of lagging inflation components and volatile prices,” Skanda Amarnath, director of Employ America, a think tank and advocacy organization, said in a commentary.
Price increases are still a top concern for consumers in public opinion polls.
“Although inflation has eased considerably from its highs in mid-2022, prices remain consumers’ top concern,” analysts for Morning Consult concluded in a Wednesday report.
The University of Michigan consumer sentiment survey showed inflation expectations for the year ahead rise considerably from January to February, jumping a full percentage point to 4.3 percent — more than double the Fed’s target.
Americans are tightening their belts
Consumer spending took a dive in January, retreating by 0.2 percent or $30.7 billion, according to the Commerce Department’s measure of personal consumption expenditures. The dip into negative territory was the first one in nearly two years.
In addition to expecting higher prices, households are also increasingly pessimistic about the financial prospects. According to the New York Fed’s survey of consumer expectations, the percentage of households that think their financial situations will get worse in the coming year jumped to 27.4 percent — the highest level since November 2023.
Consumer unease is being matched by business sentiment. The National Federation of Independent Business reported this week that just 12 percent of small businesses thought February was a good time to expand — a five point drop from January to mark the largest monthly decline since 2020.
The Atlanta Fed’s first-quarter gross domestic product (GDP) forecast has been in negative territory, but this is likely a statistical anomaly caused by a surge in gold imports prompted by tariff fears, and it won’t factor into final GDP calculations.
“It’s mostly about a surge of gold imports in anticipation of Trump’s tariffs, which is screwing up the usually helpful Atlanta model,” economist Paul Krugman wrote in a commentary.
Krugman dismissed fears of an impending recession as “premature,” though a survey of CEOs from last October by PwC found a majority of executives thought there would be a recession in the subsequent six months.
Tariffs and whipsaw trade policy
President Trump has issued a flurry of tariff orders and nearly as many retreats from those orders.
After promising 25-percent tariffs on Canada and Mexico on January 20th, Trump kicked the order back to February and then again to March. The import taxes went into effect for a few days before Trump exempted carmakers from them and then paused them for all goods covered under a pre-existing trade deal.
This week, Canada responded by putting a surcharge on electricity imports to three U.S. states, prompting Trump to propose a 50-percent tariff on some Canadian metals. Both countries walked back their new orders.
Trump has left in place a 20-percent tariff on Chinese imports, leading China to retaliate with two tranches of tariffs on U.S. energy products, farm equipment and other goods. He cancelled a tariff and inspection exemption for goods worth less than $800, but it led to a massive pile-up of packages at U.S. ports of entry, and Trump cancelled the cancellation days later.
Analysts for Deutsche Bank noted Wednesday the “increasing evidence suggesting that the Trump administration is contemplating a major reset to the global trade architecture.”
They added that “a trade war might help address the imbalance between labour and capital” in the U.S., cautioning that its ultimate impact on the US economy “remains uncertain.”
While the tariffs mostly aren’t showing up in the economic data yet, they’re certainly having an effect on the business climate.
“The business community is always going to want lower tariffs everywhere, everywhere in the world. At the moment, there is some uncertainty. The market is digesting that, but we’re going to have to watch and see how this all plays out,” Goldman Sachs CEO David Solomon said Wednesday on the “Mornings with Maria” cable television program on the Fox Business Network.
Markets keep falling
Markets were up and down on Wednesday, sensing a bit of relief in the CPI number, but they have been shedding value in recent weeks amid policy and macroeconomic uncertainty.
The tech-heavy Nasdaq is down around 10 percent over the last month. The Dow Jones Industrial Average is down around 7 percent. The S&P 500 is down around 7 percent, and the Russell 2000 index of smaller stocks is down almost 10 percent.
Many analysts are attributing market losses to Trump’s tariffs.
“President Trump’s tariff plans and the associated uncertainty are causing turmoil in the financial markets,” Beacon Policy Advisors wrote in a Wednesday analysis. “There is still a limit to the pain that Trump is willing to inflict, but the lesson from the start of the administration is that it is more than was previously expected.”
The Fed’s response
The Fed paused its interest rate cuts in January after inflation proved persistent over the fall, and many analysts believe that Wednesday’s inflationary reprieve in the CPI wouldn’t be enough for the central bank to resume.
“On its own, today’s inflation data probably wouldn’t be favorable enough to allow the Fed to cut rates in its upcoming March meeting. Combined with potential headwinds coming from tariffs, this is certainly the case,” Morningstar economist Preston Caldwell wrote Wednesday.
The economy is likely still processing some of the trillions in stimulus that went out over the course of the pandemic in the form of loans, grants and checks, which could be the reason that inflation is proving sticky.
If the Fed resumes cutting rates too soon and growth levels falter on the back of reduced consumer spending, the economy could experience the dreaded combination of inflation and stagnation.
