US Economy Shows Resilience Amid 14% Tariff Rate, 2.4% Growth Predicted

Economists like Robert Lucas and Alan Greenspan once argued that traditional recessions, characterized by a cyclical decline in demand leading to economic contraction, were becoming less frequent and less severe. This period was known as "The Great Moderation." However, this optimism was seemingly discredited by the "Great Recession" of 2008, which saw a significant decline in US GDP. Despite this, the Great Recession was more accurately a financial crisis rather than a traditional recession, and thus did not fully discredit the moderation thesis.

In the 34 years since the last traditional recession in 1991, the US has only experienced three recessions, all triggered by non-cyclical shocks: the dotcom bust and 9/11 in 2001, the financial crisis in 2008, and the Covid pandemic in 2020. Recently, there was a consensus that the US was headed for another recession, but market rallies suggested otherwise, raising the question of what could now cause a recession.

Greenspan's optimism was based on better monetary policy and the shift from manufacturing to services, which he believed made the economy more flexible and better able to self-correct. This flexibility, along with automatic stabilizers, just-in-time logistics, deregulation, and sophisticated financial markets, has given policymakers better information to work with. The US economy's ability to withstand a 10x increase in tariff rates, as suggested by recent market action, seems to support Greenspan's hypothesis.

The Atlanta Fed’s GDPNow model predicts US economic growth of 2.4% in the current quarter, and Polymarket odds of a US recession in 2025 are down to 36%. However, the current trade-weighted US tariff rate is around 14%, and analysts at Goldman Sachs said it “would probably remain elevated for the foreseeable future.” President Trump indicated that he would unilaterally decide tariff rates in the next two or three weeks, adding uncertainty to the situation.

US wages are still growing at 4.3%, well in excess of the Consumer Price Index, which ticked down to just 2.3% in April. This wage growth, particularly for job switchers, may have further to fall, as two-thirds of US workers believe they are overpaid. The beginning of globalization, marked by NAFTA in 1994, coincided with a trend change in male earnings, which began rising again after two decades of decline. Wages for the lowest quartile of earners also rose faster than wages for the top quartile starting with NAFTA.

The current House budget proposal would add $3.3 trillion to federal debt through 2034, and while it may not pass the Senate, any eventual proposal is likely to be only marginally more responsible. The really bad news about the US budget is that it’s running a big deficit while the economy is booming, raising concerns about what the budget will look like in the next recession. Deficits are good for business, though, as global equities and a 60/40 portfolio of global stocks and bonds both made all-time highs recently. If traditional recessions are no longer a concern, investing might not be as challenging as it once was.