The sequencing of policies from President Donald Trump's administration could mean slowing growth for the U.S. economy before any potential positives from promised deregulations and tax cuts. The front-loading of regressive policies--higher tariffs and federal workforce layoffs--are disrupting growth earlier than we previously projected.

As a result, S&P Global Ratings forecasts real GDP growth will cool to 1.9% in 2025 and 2026, down from 2.9% in 2023 and 2.8% in 2024, and average roughly 2.0% per year thereafter.

At first glance, our growth forecast of 1.9% for 2025 on an annual average basis suggests little change in conditions from our November update. However, on a fourth-quarter over fourth-quarter basis, we have shaved real GDP growth by approximately 40 basis points amid weaker spending by households and governments (federal as well as state and local). We now forecast the economy will only be 1.55% larger by year-end 2025 versus year-end 2024. This is a sizeable deceleration from the 3.2% and 2.5% expansion seen in 2023 and 2024, respectively.

For 2026, we see growth picking up after a slow start. This is because we see uncertainty related to the structure of tariffs abating, the Federal Reserve further easing its policy rate, and partly due to a more favorable growth backdrop in the eurozone that will support expanding U.S. exports.

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Our primary reporting cadence of growth forecasts, which is on an annual average basis, is deceptive given that GDP is coming off a high base from second-half 2024. The U.S. economy appears to have already lost some steam in early 2025, after ending last year with considerable momentum. For 2025, we believe the fourth-quarter over fourth-quarter figure provides a better summary of the expansion of the U.S. economy over the preceding year.

Weaker household income growth, reduced positive impulses from the public sector, rising tariffs, higher interest rates, and lingering policy uncertainty are key factors decelerating economic growth this year. The personal savings rate is poised to rise to more historically normal levels as precautionary behavior takes hold, reversing the trend of the past couple of years that suggested a substantial wealth effect in consumer spending, linked to stock market performance and home price growth.

As growth slows, we see demand for labor softening, with the pace of job gains falling under 100,000 a month by midyear 2025 versus the three-month average of 200,000 a month in February. The sharp decline in immigration assumed in our forecast will add to supply-driven slowing in payroll growth. In turn, we see the unemployment rate drifting up to 4.6% by midyear 2026 from 4.1% currently. This in part reflects that the reported 75,000 federal workers who have taken the option of severance will only be counted as unemployed after September if they remain so. The labor force participation rate will also decline because of the rising average age of the population, limiting the rise in unemployment rate (denominator effect).

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The public sector (federal, state, and local combined) will likely contribute zero to payroll employment for the rest of 2025, versus the three-month average of 30,000 per month in February. This is based on the hiring freeze in the federal government, announced cuts that have happened and are potentially coming, and a slowdown in hiring by state and local governments, which are constrained by balancing budgets and regardless won't offset federal government layoffs. A slowdown in the public sector will have a knock-on effect for adjacent private sector hiring--such as in the health care, education, and contract industries--perhaps more than in our baseline forecast.

Our other expectations include inflation rising temporarily in second-half 2025. Even before tariffs, a clear path to the Fed's 2% inflation target had already been pushed back. Durable goods prices started rising (again) from September, adding to inflation instead of helping with disinflation. The prices paid component of the S&P Global Market Intelligence U.S. Manufacturing Purchasing Managers' Index (PMI) has risen sharply since November, suggesting no relief in the near term. We see core personal consumption expenditure (PCE) reaching 2.8% in the fourth quarter as tariffs increase prices of goods along the domestic supply chain and to end consumers, while ongoing relative adjustments of service prices to earlier goods price gains will now take longer. We see this rise in prices limited to a one-time bump, meaning we forecast inflation will ease over the next two years to reach the Fed's target rate of 2% by 2027, and stabilize thereafter.

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In response to this rising inflation, we anticipate the Fed will keep the federal funds rate steady at the current 4.25%-4.50% for most of 2025. We think the Fed will resume cutting late in the year when employment growth comes in consistently below 100,000, a pace widely seen as "neutral" that keeps the long-term unemployment rate steady. Gradual cuts through 2026 will then bring interest rates down to 3.13% by early 2027. We continue to assume a 1.1% real neutral rate (or 3.1% nominal rate considering the Fed's 2% credible inflation target) in the long term, supporting full employment while keeping inflation stable.

In addition, we forecast the 10-year benchmark U.S. Treasury rate, which evolves with average short-term policy expectations for the next 10 years and changes in term premium, will likely be 4.0%-4.5% in 2025 before gradually moving down to 3.4%-3.6% in 2027-2028.

Changes in policies by the Fed could bring in two new marginal buyers of Treasuries, which should limit the rise in term premium of long-dated Treasuries. We suspect the Fed will end quantitative tightening altogether by year-end 2025 and add Treasuries to the balance sheet at the pace of nominal GDP growth, after announcing last week that it would further taper asset roll-offs to just $5 billion per month from $25 billion. This appears to be a precautionary step to ward off emerging money market tensions, especially in a more fraught policy world (including debt ceiling uncertainties). Potential reform of the supplementary leverage ratio under the new leadership of Michelle Bowman as vice chair of supervision at the Fed could also free up balance sheet space at large banks, making it easier for them to buy more Treasuries.

Table 1

The economic forecasts in this report reflect data available as of March 12, 2025.

The extraordinary number of executive orders (90 in the first 60 days) promises dramatic changes, with tariffs, immigration, and the size of the federal government (workforce and budget) all under the microscope.

Our forecasts incorporate assumptions on tariffs, some of which have been implemented and others that are likely forthcoming (see Key Assumptions). Upside risks to growth are that tariffs settle at lower levels or have a shorter shelf life against some trading partners, and downside risks are that the tariffs are more punitive or longer lasting, with stronger retaliation from trading partners than we have assumed.

Additionally, layoffs in the federal government and induced softening in state and local government hiring (as well as in adjacent private sector hiring) are likely to test the resilience of the economy. Consumer confidence regarding job prospects has already been hit, with many expecting fewer openings in the next six months.

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The risk of a sharper slowdown has increased amid persistent downbeat news headlines and policy uncertainty, which is leading to precautionary spending and retrenchment by households and businesses. President Trump's April 2 date for reciprocal tariffs will keep financial market trading choppy. We don't see a recession as the most likely outcome yet, having previously penciled in a 25% probability of a recession starting within the next 12 months (see "U.S. Business Cycle Barometer: Increasing Likelihood Of A Slowdown," published March 13, 2025, on RatingsDirect). However, we acknowledge that risk of a self-fulfilling downturn will rise if the current forces weighing on growth and sentiment intensify.

Recent Economic Data Shows Shifting Sentiment

Real GDP growth came in at 2.3% in fourth-quarter 2024, higher than our expectations in November, driven by very strong consumer spending.

That said, the U.S. economy appears to have lost some steam in early 2025, after ending 2024 with considerable momentum. Seasonal adjustment issues in the data, the Los Angeles wildfires, and the harsh arctic weather in most growing regions affected economic activity in January. As a result, retail sales, auto sales, housing starts, and industrial production all declined in January but bounced back in February.

The latest retail sales data, after adjusting for price changes, shows that consumers are still opening their wallets but perhaps more cautiously. Restaurant spending--a bellwether for consumer discretionary spending--declined for a third straight month in February and is an area to watch.

Housing starts jumped to 1.5 million annualized units in February, with the all-important single family starts leading the way. Builders may be complaining more about labor and material costs, but the pace of groundbreaking continues. Also permits, a forward-looking indicator for starts to come, have sustained their healthy 1.4 million-1.5 million annualized pace.

Auto sales have held up at an annualized 15.5 million-16.0 million per month while industrial production rose in February. The manufacturing new orders index as well as shipments of nondefense manufactured goods excluding aircraft--a proxy for equipment spending--have been moving sideways and not fallen sharply despite high interest rates. The semiconductors and electronics subsector continues to lead the way, with capacity utilization increasing. Announcements committing to AI-related investment outlays and complementary spending continue to roll in, an upside risk to our investment forecasts.

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In first-quarter running estimates of GDP growth, the popular Federal Reserve Bank of Atlanta GDPNow appears to be overestimating weakness (currently at a 1.8% contraction for the quarter), given its treatment of nonmonetary gold imports that spiked to a historical high in January. According to research by S&P Global Market Intelligence--a division of S&P Global, as is S&P Global Ratings--imports of gold bars shot up by more than $20 billion in January. Since the Bureau of Economic Analysis is likely to treat the transfer of gold as a nonproduction activity, it will ultimately ignore this in its GDP calculation. In our view, the first quarter has been weaker but is likely to still eke out 1% annualized growth.

At the same time, it's hard to miss the divergence between actual activity data and sentiment data. Consumer and increasingly business sentiment have soured, with federal worker cuts in the news cycle making the former wary. PMIs also show businesses have scaled back intentional capital spending in the next six months.

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Measures of the national U.S. labor market do not show a sharp deterioration yet, despite the drumbeat of layoffs in the news. The unemployment rate has remained low at 4.1%, and we would be more pessimistic if the share of permanent reasons for unemployment rose sharply--having been stable throughout 2024 after an initial rise in late 2023. That said, layoffs have increased locally where there is a higher share of federal workers, and more will likely appear from March.

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Nevertheless, annual growth in real income excluding transfers is now running near 1.5%, which suggests that exuberant real consumer spending growth is now likely behind us, especially with a fading wealth effect.

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Recession Talk May Be Overdone, For Now

The S&P 500 has declined almost 10% since its February peak, giving back all its postelection gains. In our view, some of the pullback was overdue, given historically high equity valuations, as measured by price to earnings ratios. Plus, more than 30% of S&P 500 companies' revenue is exposed to international markets, which are susceptible to tariff retaliation.

However, we think the decline was exacerbated by talk from President Trump and officials in his administration of a federal government "detox period" as spending is reduced. The equity markets are digesting the president's willingness to ride out a reaction in public opinion polls, the stock market, and economic growth, which he alluded to in a recent TV interview. As a result, recession talk resurfaced, just like in 2022 and 2023 when equity markets had a pullback.

The equity market doesn't represent the entire real economy, but 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. In our view, the probability of a U.S. recession starting in the next 12 months remains low given the current data. However, we acknowledge that the risk of a self-fulfilling downturn will increase if the current policy-induced caution in private spending behavior and sentiment (from tariff uncertainty, and especially, federal workforce layoffs) intensifies.

Monetary Policy Is In Wait-And-See Mode

As expected, the Fed left its policy rate unchanged at 4.25%-4.50% at its March 19 meeting, in a unanimous decision. The pause was its second in a row, following three consecutive cuts in second-half 2024 totaling 100 basis points (bps), and was afforded by the data.

We project the next move will be a 25-bps rate cut in fourth-quarter 2025. For comparison, the Fed's median assumption is for a 50-bps easing in 2025, according to its latest summary of economic projections. However, its central tendency (excludes the three highest and three lowest projections) moved up to 3.9%-4.4% from 3.6%-4.1%. The futures market is currently pricing in two-to-three rate cuts of 25 bps by year end.

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The Fed has moved more toward an already established "current-data-dependent" stance from a "forecast-dependent" one. This indicates that the Fed can't front-run government policy. Until it knows the sequence and structure of policy, Fed policymakers are in wait-and-see mode.

Chair Jerome Powell suggested the criteria for the next Fed cut would come when policymakers see prices behaving in a way that builds confidence that inflation is slowing. Although the case for so-called "insurance cuts" against further deterioration of the labor market has faded for now, how long until the current policy make-up starts to bite? Powell quipped that the Fed will "know it when it sees it."

In our view, employment numbers must be below the estimated neutral of 80,000-100,000 on a three-month moving average to convince the Fed that demand-side weakness will ultimately more than offset cost-push inflationary pressures from tariffs. This is different than the Fed's easing in summer 2024, which was akin to an insurance policy to keep the labor market from deteriorating further. At the time, inflation had been easing toward 2% and was lower on a month-over-month annualized basis for several months, with employment gains also below 100,000 for a few months. Today, that's not the case, with inflation trending up near 3%, and employment gains averaging near 200,000 on a three-month average from December to February.

Our baseline forecast indicates a short-term conflict between the Fed's inflation and employment mandate may occur. An inflationary increase in the price of goods and services due to tariffs could cause the Fed to choose between either accepting temporarily higher inflation or increasing interest rates, thus cooling the economy and increasing unemployment.

Central bankers should (in theory) look through the immediate inflation increase from tariffs, since it would be a supply-side shock that can't be addressed with higher interest rates. However, surveys of inflation expectations are showing higher sensitivity, with those of consumers front-running tariffs to come. We suspect that the Fed is now more sensitive to the risk of inflation expectations becoming unmoored, given the post-pandemic inflation surge. This means it may choose a longer pause or even a temporary reversal in the direction of the policy rate. Consistent with our macro forecasts, the Fed will likely not see a data-mix that supports a rate cut until late third-quarter 2025.

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Table 2

An Uncertain Outlook

Our baseline forecasts represent projections in the middle of the likely range of outcomes, after accounting for routine and nonroutine assumptions, such as tariffs in the present instance. Fluctuations in real GDP in the next two years mainly depend on movements in aggregate demand, although they are also affected by supply-related factors, such as immigration, taxes on imported goods and labor, and effects on the cost of new investments. Economic projections for later years mainly reflect the factors that underlie aggregate supply and determine potential output.

Uncertainty regarding supply-related factors is unusually high due to the unpredictability of the structure of tariffs, immigration, the size of federal government, and tax policies (see Key Assumptions). In addition, policy uncertainty could delay business decisions until more clarity emerges. Besides, there are still questions surrounding new technology-related investment and subsequent productivity growth.

Likewise, revisions to data published by the government statistical agencies that drive aggregate demand have been unusually large (COVID-19 whiplash). Survey-based private sector sentiment data has also been less reliable as a guide.

Risks to our baseline GDP growth forecasts are tilted to a downside scenario for 2025. Upside risks emanate from continuing strength in private fixed investment spending (more than our baseline envisions) while downside risks come from more cautious consumer spending than our baseline projects. A larger contraction in public sector spending is also a downside risk (see table 3 for our pessimistic scenario).

Table 3