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The economy is reeling from multiple shocks, spurring economists to reshape their outlook for growth, inflation, unemployment, monetary policy and the financial markets. The silver lining is that the economy was in good shape ahead of these shocks, with unemployment low, inflation retreating and the markets retaining most of the strong gains achieved in recent years. Hence, there is a cushion of strength to buffer the impact from the shocks. But resistance is wearing thin and the longer the shocks keep on coming, the greater the odds that the economy will fall into a recession.
The economy isn’t in or flirting with a recession, but that hasn’t stopped many from sounding the recessionary alarm. That’s not surprising. Heightened uncertainty goes hand in hand with fears of the unknown, and those fears can cause changes in behavior. It’s quite possible to talk ourselves into a recession, just as expecting higher inflation can be a self-fulfilling prophecy. It’s the job of the Federal Reserve to bring clarity and calm to the discussion so that it can identify and respond to underlying forces rather than subjective influences that it cannot control. Simply put, it needs to separate the noise from the signal when formulating rate-setting decisions.
Despite ominous signs of a slumping economy linked to tariff anxiety, the supporting evidence has yet to appear. True, the broadest measure of the economy’s overall performance in the first quarter suggests otherwise, as GDP contracted for the first time in three years. But besides being backward-looking, that headline figure is also misleading, as surging imports sliced almost five percentage points from the growth rate. Keep in mind that GDP measures the output of goods and services produced in the U.S., as well as imports that are made overseas. Ordinarily, the negative impact from imports is offset by an increase in consumption of imported goods or by an increase in inventories. But it takes time for the imports to show up on the positive side of the ledger, indicating that an offsetting growth boost will show up in the second quarter.
By recent standards, it was a relatively calm week on the policy front as President Trump dialed down his tariff threats, hinting at a de-escalation of tensions with China, and walked back his attacks on Fed Chair Powell. Nothing concrete was put on the books, but the tamer messages emanating from the White House were instrumental in arresting a free-fall in the financial markets this week. Stock prices staged a solid recovery, bond yields retreated, slipping well below the nearly 4.5 percent peak reached two weeks ago, and even the beleaguered U.S. dollar reversed its extended decline, bouncing off its three-year low.
A cynic might say that there is method to the madness that some believe is driving the chaotic tariff blitz that is roiling the financial markets. While the markets are climbing a wall of worry, the current economy is reaping the benefits of that worry. Simply put, anxious consumers who are expecting higher prices on the things they buy are ramping up purchases now. And since consumer spending is the main growth driver, the economy is cruising along on a higher gear than it otherwise would. For now, at least, President Trump can claim that the worry is exaggerated, just look at the data.
The shape-shifting nature of President Trump’s tariff threats continued to roil the financial markets this week, producing one of the wildest gyrations in stock and bond prices seen outside of major, shock-induced crises. What’s more, it’s not likely that volatility will subside anytime soon. The sigh of relief when Trump postponed onerous reciprocal tariffs on most trading partners for 90 days did not last long. Within the blink of an eye following that concession, trade tensions with China escalated; Trump upped tariffs on China to 145 percent and China quickly retaliated by increasing its tariffs on U.S. exports to 125 percent. The deteriorating relationship between the world’s two largest economies shows no sign of easing, although China signaled that it would not engage in further tit-for-tat tariff increases.
The aftershocks of Trump’s onslaught of tariff announcements are still reverberating through the financial markets, adding another layer of uncertainty that has buffeted households and businesses for months. At the end of trading on Friday, investor stock portfolios absorbed a collective hit of about $7 trillion since the bombshell Rose Garden theatrics took center stage. The math is admittedly back of the envelope, based on the Federal Reserve’s estimate of the total value of publicly held U.S. stocks, which stood at $70.3 trillion at the end of 2024, and we estimate declined to about $66 trillion on the day of the aggressive tariff announcements. The more than 10 percent plunge on Thursday and Friday translates into about a $7 trillion haircut to investor stock portfolios, give or take a few billion.