Inflation is no longer the scariest risk

US Economy Rising

Downside risks to the U.S. economy are rising. The labor market is no longer as robust as it once was: rates of hiring and firing remain lower than pre-pandemic levels, while layoffs are rising. Additionally, sources of growth have narrowed and the housing market has stagnated. Changing political winds in Washington have also added to uncertainty. All of this contributes to a more dim outlook for 2025 – even if many economists and analysts are reluctant to admit it.

To prevent the economy from worsening, the Federal Reserve will be forced to accelerate its policy, and support activity by cutting interest rates far more aggressively than its members or investors currently expect. Based on the market's underlying outlook, investors expect to see two rate cuts by the Fed in 2025. But as the true picture of the economy becomes clearer, I would expect a few more cuts before the end of the year. After years of warnings that a recession was imminent, economists and Wall Street analysts have largely abandoned the idea of ​​a recession or significant slowdown in growth in the United States. But with the main parts of the engine slowing and the Fed sitting idly by and doing nothing, the chances of the economy weakening significantly are rising.

Any rational reading of the data points to a clear slowdown in the US economy. Sure, GDP growth in 2024 will be a respectable 2.5%, but that will be less than the 3% of 2023. And the way the US achieved this growth was not particularly encouraging. Household consumption and public investment accounted for the biggest share of growth last year, while gross private domestic investment – ​​which reflects the amount of money companies invest in their businesses and the amount spent on building new homes, apartments and other structures – was down only slightly. Given the narrow pattern of growth, it could be argued that if consumer spending and public investment fall, so will the economy. There is a strong case for slowing in both categories.

Consumption possibilities are tied to income

People can spend more money only if they have more money. And it is clear that income growth is slowing as the labor market cools. The attrition rate will reach a new low by the end of 2024, and wage growth will slow as layoffs decline. This is true: when fewer workers leave their jobs, employers feel less need to raise wages to keep them on the job, shifting power from workers to employers. And as incomes slow, so does consumption. In fact, we have already seen part of that decline: inflation-adjusted income minus transfer payments – a proxy for people’s wages excluding government benefits such as Social Security and Medicaid – was one percentage point below the consumption rate. At the same time, the personal savings rate (a measure of the percentage of money people have saved) fell from 4.4% to 3.8% in 2023, suggesting that Americans are drawing down on their reserves to support spending. But there is a limit to how much consumers can spend on fuel.

Another pillar of US growth, government spending, is also showing signs of strain – and not just because of the Elon Musk-backed DOGE cut. The United States has seen huge cash surpluses during the pandemic years, but these surpluses are disappearing fast. State and local government construction spending will grow 4.4% in 2024, up from 19.7% in 2023. State and local government hiring is also declining. A recent Pew report said, “State budgets are expected to shrink significantly in fiscal 2025, as the pandemic ends an era of subdued revenue growth, record spending and historic tax cuts. According to new data released by the National Association of State Budget Officials (NASBO), total general fund spending is expected to fall to $1.22 trillion, more than 6% below the level projected in fiscal 2024, which ended June 30 for most states.”

Component of GDP

Even spending on new housing, the weakest component of GDP over the past year, will be worse off in 2025. Interest rates remain high as incomes decline, creating affordability problems that make it harder for people to buy homes and increasing the number of homes on the market as sellers take longer to find buyers. Redfin recently said, "An increase in new listings and slower sales are leaving more inventory available for home buyers to choose from. As a result, a typical home sold for 2% less than the asking price, the biggest discount in two years." This slowdown in growth will bring serious consequences for Americans. One of the obvious disadvantages is the potential loss of