The Downside of the Market's Recovery

The U.S. economy has clawed its way toward a fragile recovery in early 2025, but beneath the surface, the foundations of this rebound are riddled with vulnerabilities. While consumer spending and corporate earnings have held up, the path ahead is shadowed by stagflationary pressures, policy uncertainty, and global trade tensions. The market’s rebound, driven by resilient wage growth and private equity investments, masks a precarious balance between growth and risk. Investors would be wise to scrutinize the cracks in this recovery before assuming it is set in stone.

The Fragile Foundation

The U.S. economy’s 2.0% GDP growth forecast for 2025 is under siege. Universal 10% tariffs on imports, compounded by retaliatory levies from 60 nations, have raised effective import costs above 20%, inflicting a potential 2.3% GDP drag by raising input prices for sectors like autos and electronics. . Even as the labor market has stabilized—with unemployment at benign levels—hiring has slowed, and wage growth, though positive at 1% above pre-pandemic trends, may not keep pace with inflation. Meanwhile, consumer spending, which surged at a 7% annualized rate late last year, is cooling as households face higher prices and fiscal austerity.

Inflation’s Shadow

The Fed’s core PCE inflation target of 2.8% for 2025—up sharply from 2.2% six months ago—reflects a troubling new normal. Services inflation, which accounts for two-thirds of the index, is rising 1% faster than pre-pandemic trends, while goods prices face upside risks as tariffs squeeze supply chains. The University of Michigan’s one-year inflation expectation hit a 32-year high, signaling a dangerous shift in public sentiment. . With input costs climbing in tariff-exposed industries, businesses are passing on these costs to consumers, stifling the disinflationary process.

Policy Uncertainty: The Wild Card

The single greatest threat to the recovery is policy uncertainty. Tariffs are now projected to boost core PCE inflation by up to 1.5% in the first year, exacerbating stagflation. Meanwhile, fiscal austerity—through delayed infrastructure spending and potential public sector layoffs—could further dampen demand. Companies, meanwhile, are holding back on broad investments until clarity emerges on trade, immigration, and regulatory frameworks.

The Fed’s hands are equally tied. Despite GDP forecasts now revised downward to 1.9%, the central bank has delayed rate cuts, now projecting only 100bps of easing in 2025—far below market expectations of 75bps. This disconnect risks destabilizing markets, particularly if bond yields spike.

Global Headwinds

The U.S. recovery is also buffeted by global crosswinds. China’s property slowdown and emerging market inflation volatility have amplified downside risks, while reciprocal tariffs have fragmented global trade. The EU’s fiscal stimulus in infrastructure and defense provides some offset, but monetary easing elsewhere—save for Japan—has done little to ease trade tensions.

Market Vulnerabilities

Even asset markets, which have stabilized, are far from safe. U.S. equities trade at 20x earnings, a level that may prove precarious if growth disappoints further. . Bonds, meanwhile, face stagflationary headwinds, with higher volatility and correlations to stocks. Private credit offers spreads of 200bps over public markets, but performance varies widely as tariff impacts hit sectors unevenly. Commercial real estate, while stabilized, lacks upside with the Fed on hold.

Conclusion: A Recovery Held Together by Threads

The U.S. economy’s recovery is a mosaic of resilience and fragility. While wage growth and private equity investments provide a floor, the risks of stagflation, trade wars, and policy missteps loom large. The 2.3% GDP drag from tariffs, the 1.5% inflation shock they may unleash, and the Fed’s constrained policy space paint a picture of an economy teetering between expansion and stagnation.

Investors should remain cautious. Sectors exposed to trade—like autos or tech—face steep headwinds, while inflation-sensitive assets like bonds carry hidden risks. Private markets, particularly middle-market firms insulated from trade wars, may offer better value, but returns will hinge on regulatory clarity and global coordination. As the Fed’s own projections make clear, this recovery is neither robust nor assured—it is a temporary reprieve built on sand.

In such an environment, the best defense is diversification and a long-term horizon, with an eye toward the day when policy clarity and global cooperation can solidify what is, for now, a tenuous rebound.