And Now the ‘Finding Out’ Part: Jumping Through the Tariff Door
- US effective overall tariff rates are now higher they were after the Smoot-Hawley Act in the Great Depression. We also import roughly 3x as much, as a share of GDP, as we did then.
- Shocks to growth are not just about uncertainty. We resolved some uncertainty today, but the outlook is worse. The actual policies being implemented are bad for growth and any possible boons, about which I am beyond skeptical on net, are in the distant future.
- I am not sure that a ‘true’ broad-based recession is now the base case given the US economy’s lack of private sector vulnerabilities going into the year, but the growth outlook now centers around something close, although probably still a bit above, 0%. This is at best an unnecessary low growth slog. Just ballparking it but from a 1-1.5% baseline for 2025 this AM, we are looking at 1.5-3% additional hit to GDP spread over 2-6 quarters. That could well manifest as a fairly small recession. Given tracking for Q1 and the likely impacts over the next few quarters, one cannot rule out at least a technical recession.
- If one takes a now current policy baseline forward, core PCE forecasts for 2025 should be revised into the 4-5% range. The low-to-mid 3s seemed appropriate based off policy this morning. Excess precision feels unnecessary and impractical. There is now going to be the feared second wave higher of core PCE inflation.
- The announcement today will likely be toned down some over time but that is far from guaranteed, and the secondary impacts of the tariffs may swamp that. Fiscal policy could be a partial offset eventually but that also makes the inflation and term premia problems worse, and is likely to have a much smaller dollar-for-dollar multiplier than the tariffs do.
- Friday’s employment report seems even more out of date and is probably only appreciably relevant if it showed any prior further weakening of the labor market.
Given the growth shocks that will be realized, regardless of the precise policy path followed, the issue for those saying it is just a part a negotiation process, they have to ask what is the ultimately goal of this process? Is it good for the economy and markets on different horizons? Are those goals credible given the instruments being used and their impacts? There remains a substantial degree of uncertainty about the ultimate aims of these policies, but their sheer scope is suggestive of greater persistence and belief in fundamentally wanting to change the US economy than more modest tariff policies would have suggested. That comes with greater Knightian risks but also greater risk of political, business community, and economic blowback.
The scale of this announcement, wherever it ultimately leads, makes the Fed’s job substantially more difficult than would a smaller shock because while recession risks rose nonlinearly too, the inflation path is shooting higher along with concerns around regime shift driven risks to inflation expectations (here) will make the very cautious about any preemptive easing, or even easing in response to mildly worse than expected labor market outcomes.
Tariffs are a tax, with a fairly high multiplier that also raise inflation in addition to lowering growth. All the hemming and hawing about negotiation and that this is a possible upper bound will not change that basic fact. Indeed, negotiations could go poorly and lead to an escalatory cycle of mutual retaliation. Bessent’s statement that these are a ceiling seems minimally credible given where we are in the process. Press releases by industry lobbying organizations in DC afterwards strongly hint at the possibility, or at least hope, of eventual carveouts, which cannot be dismissed. If realized, while the political economy of somewhat random connections-driven decreases in tariffs is far from societally optimal (so are tariffs admittedly), this could attenuate the blow some. But this all remains to be seen.
Going into the year there were two basic fact patterns which led to me to think that the odds of a recession were above normal but that if one did take place it would likely be fairly small (see more here). A slowing growth baseline due to a weaker supply side picture, an unemployment rate slowly rising off its cycle lows along with most other measures of slack, inflation above target, and rates somewhat above neutral were set a less than helpful mid-to-late cycle baseline but also did not doom the economy. The private sector’s imbalances remain modest in size, reducing recession severity risks.
Given baseline tariff impacts we will likely see growth dip very close to 0 for some time. That may be survivable without a broad-based recession that ticks off all the NBER boxes, but it will be an unnecessary low growth slog and may well be much worse than that. Much depends on the current unknowable uncertainties around sentiment and market responses, retaliation and negotiation, and lobbying around domestic exclusions.
The labor market baseline before today was some gradual easing in slack over H1 before slow immigration meant that a modest 75-100k pace of NFP growth in the back half of the year saw slack slowly stabilize and perhaps even slightly retighten. Usual macroeconomic relationships may not hold particularly well under the circumstances but using a fairly normal Okun’s Law relationship between GDP growth relative to potential and changes in the unemployment rates suggest that, if growth is as weak as I noted above, the unemployment rate would rise to 5% or a bit above. If more mild recessionary dynamics take over, I’d raise that range towards 5.5-6%.
