Economy Commentary
The Economy
Mounting Downside Risks Amid Heightened Uncertainty
March 2025
Over the past few months we’ve cautioned that an uncertain and rapidly changing policy environment could weigh on economic activity and lead to heightened volatility in the financial markets. The past few weeks have been a prime example of what we had in mind when we first began raising those concerns. To be sure, the U.S. economy continues to push forward, but the path forward has become much rockier and far less clear. While at present our base case is that the economy will continue to expand, we now anticipate slower real GDP growth and higher inflation than we expected coming into 2025, and we consider the risks to our baseline forecast to be weighted to the downside. That is, we think, also the signal being sent in the financial markets, with sharp declines in yields on U.S. Treasury securities and significant declines in equity prices signaling more concern over the prospect of flagging growth outlook than the prospect of higher inflation amid wavering consumer and business confidence.
Consumers’ moods have meaningfully soured thus far in 2025, which is visible in both the Conference Board and the University of Michigan survey data. On top of the stress being caused by cumulative price increases over the past few years, consumers are now increasingly worried that higher tariffs will lead to further price increases. Uncertainty over tariffs, particularly given the on/off nature seen over the past several weeks, is impacting business decisions on purchases of raw materials and intermediate goods, capital spending, and hiring. To that point, the Institute for Supply Management’s (ISM) February survey of the manufacturing sector shows some firms putting off placing orders due to uncertainty over tariffs, while others report input prices already rising in anticipation of tariffs. Moreover, the speed and scope of cuts in federal government employment and spending are contributing to a sense of unease amongst both consumers and businesses, particularly given the potential spillover into the private sector in areas such as education and health care. The ISM’s February survey of the services sector conveys concerns along these lines.
Many are quick to dismiss confidence surveys and the ISM surveys as “soft” data which does not necessarily impact the “hard” data, such as consumer spending, business investment, and nonfarm job growth. Market participants may have been inclined to do the same with the most recent batch of survey data had that survey data not coincided with a run of hard data coming in below expectations. For instance, we noted last month that January’s gain in nonfarm employment came in handily below expectations, sparking concern over the labor market and the broader economy despite the details of the January employment report being stronger than implied by the headline job growth print. The January employment report, however, was followed by reports showing sharp declines in retail sales and residential construction in January, while at the same time January’s 0.5 percent increase in the Consumer Price Index (CPI) – with no help from tariff-related price increases – triggered fears that inflation was reigniting.
While we’ll admit to having been somewhat flustered by the wave of disappointing data, our task is, as always, to dig beneath the headline numbers and decipher the message in the details of the data. Along those lines, we think the following points are worth making. First, atypically harsh winter weather across much of the U.S. in January clearly had an impact on the economy. Yes, there is a winter every year and, sure, it’s always cold in the winter, but the key words in the above sentence were “atypically harsh,” as evidenced by significant snowfall across much of the South. The impact of January’s atypically harsh winter weather is clear in the data on nonfarm employment and hours worked, residential construction, industrial production, and consumer spending.
We’ll also note that, for many data series, seasonal adjustment was much less generous this January than has been the case over the past several years, which to some extent could reflect seasonal adjustment catching up to the pandemic having triggered significant disruptions in what for many years had been stable seasonal patterns. For instance, the not seasonally adjusted data show this January’s declines in nonfarm employment and control retail sales to be right in line with typical January declines, but in each case less favorable seasonal adjustment contributed to a softer headline print than would have been shown had last January’s seasonal factors been applied. In other words, less generous seasonal adjustment impacted perceptions of much of the January data.
Finally, recall that consumer spending, particularly on consumer durable goods, was notably strong over the final few months of 2024. There is evidence, including from the University of Michigan’s surveys, that consumers were pulling purchases of big-ticket items, including motor vehicles, forward into 2024 to avoid tariff-related price increases in 2025. Additionally, late-2024/early-2025 data on inventory accumulation, factory orders, and trade flows have been impacted by firms attempting to front-run higher tariffs. To the extent consumers and businesses were engaging in such behavior, there will naturally be payback, and we think we’re starting to see some of that in the recent data releases.
To be clear, this is not us trying to explain away a run of subpar economic data and make a case that all is well with the U.S. economy but is instead simply our usual attempt to put the data into proper context. After all, how one feels about the economy should be determined by what is actually happening in the economy and not by, say, the size of a seasonal adjustment factor. Be that as it may, while we did not find anything particularly amiss in the unadjusted January data, we are nonetheless increasingly concerned over what we perceive to be mounting downside risks. Some of these downside risks were ones we had flagged coming into this year but which now seem more threatening, while others have emerged more recently.
As an example of the former, coming into this year we highlighted the risk that, should they perceive that demand for their goods/services is eroding, firms may be more inclined to let workers go, particularly to the extent that softening labor market conditions lessen the rationale for firms to engage in the labor hoarding behavior that we and many others have argued has been practiced in the post-pandemic years. Though we remain concerned over the prospect of an adverse labor supply shock stemming from immigration reform, we now see weakening demand for labor to be the more pressing downside risk to the labor market. This is one reason to not dismiss reports of flagging business confidence out of hand.
As for newly emerging downside risks, sharp cutbacks in federal government employment and, potentially, research and grant funding are hitting, rather abruptly, at a time when the economy is already slowing, and we do not yet have a way to gauge the potential spillover into private sector activity. But, the prospect of a few hundred thousand workers being displaced in an already cooling labor market could easily push the unemployment rate higher than we had been anticipating. Additionally, recent sharp declines in equity prices and what in many markets are softening house prices raise the potential of negative wealth effects leading to cuts in discretionary consumer spending, which could be significant given the degree to which higher income/net worth consumers have been driving overall consumer spending.
The path ahead for the U.S. economy looks much rockier than it did coming into this year. Yet another round of atypically harsh winter weather left a mark on the February employment report and will likely do the same with the data on residential construction and retail sales. Another round of disappointing data won’t make anyone feel any better about the growth outlook and, looking ahead, the March employment report will be the first to show meaningful impacts from cuts in the federal government workforce. It is not difficult to envision a negative feedback loop in which disappointing “hard” data further depresses business and consumer confidence which, in turn, blows back on consumer spending and business investment/hiring. These conditions could prevail until there is more clarity on the policy front.
Sources: Bureau of Economic Analysis; Bureau of Labor Statistics; U.S. Census Bureau; Conference Board; University of Michigan Survey of Consumers; Institute for Supply Management
As of March 11, 2025
