S&P Global Ratings Economics now believes there's a 25% probability of a U.S. recession starting in the next 12 months.

This is different from what our preferred econometric model indicates. Using data through February, that model puts the odds of a U.S. recession starting in the next 12 months at 5%-10%, lower than the 20%-25% odds it saw at the end of last summer.

But we think uncertainty for businesses that rely on global supply chains, immigrant labor, and government services could negatively affect domestic demand, the labor market, and prices--more than our recession model currently suggests. In addition, the tariffs that U.S. President Donald Trump's administration has imposed on Canada, China, and Mexico--as well as the tariffs that are likely to come after April 2--could have more serious consequences for the U.S. economy than what our quantitative model currently suggests if the tariffs aren't soon lowered or removed.

There's an increasing risk that supply-side shocks from tariffs, decelerating immigration growth trends, and curbs on the federal government workforce will create a lasting negative feedback loop that weakens aggregate demand.

At any given moment, it's a difficult exercise to assign probabilities to economic trends, and it's perhaps even more so in the current policy environment--with policy uncertainty at historically high levels.

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The lower probability of a U.S. recession in our quantitative model largely reflects the disinversion of the yield curve since late last year. These signs of normalization for the yield curve primarily reflect:

• A view that the markets no longer think the Federal Reserve will push the economy into recession, or believe that recession risks have significantly diminished (given the Fed's recalibration of the policy rate via 100 basis points of rate cuts). There's very little precedent for the Fed to cut when there isn't an economic downturn. But we have seen a rate recalibration via rate cuts before--in 1966, 1995, 1998, and 2019.
• A view that the Fed had temporarily pushed rates above their long-run average specifically to address inflation, and that it can now can safely normalize monetary policy with a patient approach without endangering economic stability.

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Economic Activity Appears To Be Stronger Than The Negative Headline Figures Suggest

U.S. economic indicators for January were mostly downbeat on the surface, suggesting a significant slowdown in the first quarter of 2025. But we think one-off factors were behind most of this apparent weakness.

As of March 6, the most popular real-time GDP tracker, the Federal Reserve Bank of Atlanta's GDPNow, estimated a real GDP contraction of 2.4% (annualized) for the first quarter. And the 10-year Treasury yield has fallen to 4.2%, from a peak of 4.8% in January.

But in our view, most of this weakness was due to things like January's arctic blast in much of the U.S. and an unusual widening of the trade deficit (without a concurrent spike in inventories). A significant contributor to the trade deficit widening in January was a $19 billion increase in nonmonetary gold imports, to $32.6 billion.

According to the Atlanta Fed's Patrick Higgins, who helped develop GDPNow, the "gold-adjusted" GDPNow running estimate stands at positive 0.4% real GDP growth (a 2.8-percentage-point swing that also accounted for the inclusion of new February employment data).

In addition, while higher imports take away from GDP, they rarely reflect a fundamentally weak economy. If there was a weather-related rebound in consumer spending in February (as we expect), we think consumer spending would still be on track to expand by 1.5% (annualized) quarter on quarter--hardly a sign of an impending recession.

The traditional coincident indicators of economic growth and real-time nontraditional data give a mixed picture of where U.S. growth momentum is headed (see the Appendix).

One key coincident indicator is payroll employment, and the data for February suggested that jobs growth in the U.S. is above what we see as the longer-run neutral pace of jobs growth. (We now consider 80,000-100,000 added jobs in a given month to be a neutral pace of job growth, with the sharp slowdown in immigration curbing population growth. This threshold was 175,000-200,000 in 2023 and 2024.)

The federal government (which accounts for 1.9% of overall payroll) subtracted jobs in February, and more job losses will likely show up in the March payroll data. Despite the layoffs in the federal government, the overall underlying trend in jobless claims is flat through the first week of March (see chart 12 in the Appendix).

Industrial production has been moving sideways for some time now, and so have real manufacturing and trade industrial sales. Growth in real personal income excluding transfers has continued to slow, reaching 1.5% (year on year) in January--significantly slower than 3.5% two years ago.

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Mixed Signals From Leading Indicators

Our comprehensive dashboard, which includes nine leading indicators, offers a nuanced perspective on near-term U.S. growth momentum prospects. Currently, four indicators are showing negative signals, while five are neutral or positive. Manufacturing new orders and bank lending conditions remain in the red, while consumer sentiment and equity market conditions turned negative just recently.

Higher inflation expectations have hurt consumer sentiment, and The Conference Board's consumer confidence index is showing a deterioration in sentiment from negative news cycles about labor market conditions.

Meanwhile, the S&P 500 has declined by almost 10% since its February peak, giving back all of its post-election gains. Some of the pullback was overdue, in our view, given historically high equity valuations (as measured by price/earnings ratios).

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The equity markets are digesting President Trump's willingness to ride out a reaction in public opinion polls, in the stock market, and in economic growth, which he alluded to in a TV interview that aired this past weekend.

The markets are also wary of the possibility of a U.S. government shutdown at the end of this week. Our previous work on government shutdowns suggests that GDP growth inches lower by between 0.1 and 0.2 percentage points for each week a shutdown lasts.

Normally, there's a rebound the following quarter, when furloughed workers come back. This time, there's the risk that the Department of Government Efficiency initiative, led by Elon Musk, could consider temporarily nonessential functions as permanently nonessential.

The equity market doesn't represent the entire real economy, but right now, the wealth effect is relevant. A persistent stock market pullback combined with a supply shock would raise the odds of a negative feedback loop weakening aggregate demand. The probability of a U.S. recession starting in the next 12 months remains low given the current data, but if we consider upcoming policy, the odds of a recession are higher. In terms of timing, the negative impact of these policy changes should come ahead of potential tax cuts, which are currently slated for the end of this year.

All of that said, weaker average quarterly GDP growth (at 1%-2%) is, in our view, more likely than two consecutive quarters of contraction (which, by itself, still would not meet the National Bureau of Economic Research's definition of a recession).

Given the mixed picture provided by leading and coincident indicators, we think it's too early to tell if a new economic trend has emerged. That said, policy-related volatility will continue to play a role in the U.S. economy going forward.

The Fed's stance on monetary policy remains modestly restrictive, and the central bank is in a "wait and see" mode amid various one-off distortions in economic data and the uncertainty surrounding the Trump administration's policy mix. A conflict appears to be brewing between the Fed's inflation and employment mandates, with increasing downside risks to growth and upside risks to inflation.

Appendix

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