The U.S. Economy: A 2025 Outlook

With the new year ahead of us, there's a great deal of excitement and uncertainty about the economic outlook. The excitement surrounds an economy that is solid with no signs of significant slowdown. It's firing on all the primary cylinders.

President Trump will be taking control of an economy that is stronger than the one he had in 2017. There are 12 million more people working compared to then, and the economy is about 16% stronger. As for the uncertainty, it surrounds the president's planned policy objectives of higher tariffs, lower taxes, and reduced immigration. It is much too early to assess the impact that it will have. We do know what was discussed on the campaign trail, but we don't know what will be implemented. This will determine the economy's trajectory going forward.

Let's take a look at some of the charts of the essential parts of the economy.

Chart 1, 1:13– We will start with GDP. As I mentioned, the economy is on solid footing. This data of the economy is up until the end of the third quarter. The columns represent the quarterly change in GDP, and the dark blue line shows the yearly change. Growth has been steady and increasing at a pace above the Fed's ideal rate.

This chart shows that the yearly change in GDP growth is at 2.7%, nearly a full percentage point above the 1.8% growth rate that the Fed believes is ideal for generating strong labor growth without increasing inflationary pressures. The economy is benefiting from a low unemployment rate, income that is higher than inflation, many households that have locked in low mortgage rates so they're not sensitive to high interest rates, and fiscal stimulus.

Chart 2, 2:04– Labor is also doing well. This chart shows that nonfarm payrolls have gained positive momentum for 48 straight months, tying the record for the second-longest streak since 1940. The only exception was after the global financial crisis that had a long period of growth. Growth in labor demand is expected to continue as the administration focuses on reducing regulations and cutting taxes. With a high level of confidence in continued labor growth, the focus is on inflation.

Price pressures have calmed down compared to the peak of 9.1% in the summer of 2022. They're now hovering around 2.5% to 3%, depending on the inflation measurement that you're looking at. It's still above the Fed's target of 2%. The Fed is confident that inflation will continue to move toward target. The past year has been challenging for them, and that's been primarily due to the high level of inflation for housing.

Chart 3, 3:03– The new administration is concerned about the large trade deficit. In this chart, the U.S. has a trade surplus of services.

Services are in the dark blue line, and it makes up about one-third of all exports. That's anything from foreign companies using our legal or financial services to foreigners traveling to the United States for tourism. The light blue line is the deficit for goods, which more than offset services producing the net trade deficit. The deficit for goods has increased over the past few decades as Americans have become accustomed to cheaper prices and the quality of imported goods.

On the far right, in the past year, the goods deficit, which was getting smaller, reversed course as many importers increased the pace of imports, fearing possible future tariffs. The tariffs are away. The administration hopes to reduce the trade deficit by making imported goods more expensive.

Now the talk of heavy tariffs is creating fears of higher inflation. It is not known how high the tariff rates will be or how extensive. The feeling is if the tariffs are imposed all at once, the Fed will probably look through that issue. Yes, there will be a price jump, but one year later, the yearly change will return to a level around the previous trend. However, if the tariffs are doled out over time, that may impact customer behavior. This is where the Fed will be concerned. Prices rising over a period of time is apt to increase consumers' inflationary expectations.

Chart 4, 4:42– In this chart, there are various measurements of inflationary expectations. The top two in dark blue and bright blue are the outlook for the next one year. You can see the jump in 2022 when inflation spiked.

Now the bottom two in gray are a longer-term view of five years or more, and that was steadier during the 2002 inflation jump, indicating that consumers thought that inflation pressures that were going on would be short-lived. The important issue here is that they have all come down, albeit at a higher level than before the pandemic. That is partially due to the fact that inflation is a little higher now than it was then. The Fed and the markets will be closely watching these indicators to see if they start moving up.

Chart 5, 5:31– Substantial uncertainty surrounds fiscal policy. However, based on current policy, planned policy changes, and history, the deficit is expected to increase.

In regard to recent history, the deficit has increased on average of 30% for each presidential four-year term. The large and expanding federal debt is becoming a concern for the financial markets. The federal debt has doubled in the past decade and is nearly $36 trillion. The debt servicing costs have jumped in recent years. We now spend more on interest payments each year than we do on defense or Medicare. Most economists believe that to be sustainable, the deficit, which is the annual change, should grow at a pace that's slower than the economy is growing. If the economy can grow at 3%, the deficit should grow at 3% or less. In fact, that's the plan of the new treasury secretary. But right now, the deficit is growing at around 6.5%. Interest payments alone are above 3%. This is sure to be an important topic for the new year.

Chart 6, 6:43– Finally, the Fed.

We believe that they will continue to lower the federal funds rate over the course of the year. The current rate is 4.375%. We believe that the Fed will cut that rate once or twice this year at 25 basis points per cut. The next column in this chart shows that the Fed's projection that they made back in December is for two cuts, bringing the rate down to 3.9%. It's in the same general range as the Bloomberg Composite of Economic Forecast and the Federal Funds futures market. This, of course, is a slower pace of using monetary policy. The planned decline of 50 basis points over this entire calendar year is a much slower pace than what we had last year, when the Fed cut rates by 100 basis points in the last few months of 2024.

The Fed has shifted its focus to fine-tuning the economy to keep it on its upward trajectory. Those are the key issues, but there are some other issues worth following. The U.S. economy has a key advantage over other economies around the world. The most notable and unique is AI. There is very little artificial intelligence in Europe, Japan, or even our neighbor, Canada. This is a powerful tailwind that has the potential to lift productivity. On the other side of the coin is the worldwide geopolitical challenges that will likely continue to be a headwind.

One thing we know about 2025: You can bet on the fact that it will not be boring.