A former Fed economist forecasts US growth and the 3 biggest risks for markets
- Investors’ optimism for 2025 is waning as market risks increase, impacting stocks.
- Economic concerns, including inflation and tariffs, are top risks for corporate leaders.
- Geopolitical risks and federal disruptions could further strain the US economic outlook.
Investors’ high hopes coming into 2025 are slowly being dashed.
The optimism that was priced into the market is starting to reverse course. The S&P 500’s pullback last week could indicate that investors are reducing their risk appetite, said Julia Coronado, president of the research firm Macropolicy Perspective.
All three stock-market indexes closed down on Friday amid flashing signs of a slowdown in US growth. The US Composite Flash PMI Output Index, which measures monthly changes in goods and services, neared contraction territory in February and hit a 17-month low.
Consumer spending, the economy’s main driver, may also be at risk. The University of Michigan Surveys of Consumers posted on Friday showed sentiment fell for the second consecutive month by nearly 10% from January.
None of this comes as a surprise to corporate insiders. A recent survey by Protiviti and North Carolina State University, which polled 1,215 board members and C-suite executives about their biggest concerns, put economic conditions, including inflationary pressures, as the top risk in their near- and long-term outlooks. It means that corporate activity, and specifically spending, is teetering on clarity around tariffs. And so, the PMI’s contraction is just an uncertainty tax, Coronado said.
“Tariffs in and of themselves aren’t a problem,” she said. “If you tell me what the tariff is, then I can factor that into my supply chain management, my cost structures, my pricing strategy.”
As a former economist for the Federal Reserve Board, she believes it will take further policy clarity from Washington before spending can resume. So far, only a 10% tariff against imports from China has been implemented. Everything else is still hanging in the mix, including the possibility of counter-tariffs.
Sentiment and outlook shifts
Markets came into the year sanguine, she said. The response to the election was positive. Expectations were focused on growth elements like tax cuts and deregulation. But we are getting hit with more negative or disruptive parts of policy first, like immigration reforms that tighten labor supply, tariffs, and a wave of government job cuts, she added.
Meanwhile, any positive impacts of deregulation are harder to calibrate into the economy and will take a long time to reflect. It will also take more time to get tax cuts or see their benefits, she noted. All this is gradually making sentiment more negative.
The last couple of years featured better-than-expected cooling on inflation alongside a resilient economy. The Fed’s preferred measure of inflation, core personal consumption expenditures, which excludes volatile food and energy prices, hovered at 2.8% at the end of last year. Before the threat of tariffs, Coronado was forecasting continued progress toward the Fed’s 2% target. But that’s now changed. She expects inflation to stall and remain close to 3% instead of cooling down, with risk to the upside in the second half of the year if more tariffs begin to trickle in.
“What we saw last time we did a trade war under Trump’s first administration is it kind of hit the global manufacturing sector and took the sector into recession,” she said. “The Fed, because inflation was low at the time, was able to cut rates and soften the blow. We don’t think that’s the case this time because inflation is above their target. So they won’t be cutting rates anytime soon. And you will see the pass-through impact of some of these policies on growth.”
She doesn’t expect any rate cuts until the second half of the year.
“Now, why do we have the Fed cutting at all is a good question. And that comes down to: we do expect that growth will cool,” she added.
Her forecast for US GDP is 2.5% for the early part of the year but slowing to 1% by the fourth quarter. The job market is also expected to slow down, going from an average of 175,000 jobs created monthly to below 100,000.
The next indication that fear is spreading through markets is a widening of credit spreads as investors demand higher yields for taking on more risk of default, which is what Coronado will be watching for.
Biggest risks
The risk of a recession is always there. In any given year, it sits at a 20% chance, but Coronado has set a 35% chance of a recession over the next 12 months.
Her biggest fear is geopolitical risks and shifts in alliances between countries. On the pro side, conflict would be a positive for the defense sector. On the cons side, it would negatively affect the European economy. As for Mexico and Canada relations, if tariffs are implemented, it would negatively hit the auto sector.
Her second concern is disruptions to the federal payments system and contracts, which are being witnessed amid the DOGE shake-ups that are laying off federal workers and trying to cut down spending. This will especially hit sectors such as renewable energy, agricultural firms, and even payments to hospitals that are being interrupted.
“As a macroeconomist, I tend to think that one of the ingredients to US exceptionalism is stability and the rule of law,” Coronado said. “So we’ve seen a lot of disruptive actions that directly involve payment systems and being a person that’s in markets and appreciates liquidity and efficiency of operations, it worries me to see chaotic intervention.”
As for AI stocks, there’s too much speculative excess priced into their valuations, she noted. Even big winners like Nvidia, with wide profit margins, are expected to see a slowdown in growth as the company matures and competition increases.
AI’s impact on productivity is real and will be a positive tailwind. Still, for now, markets may have gotten ahead of themselves as they bet on what she believes is unsustainable valuations. This suggests that the resilience of Big Tech’s ability to carry the market through uncertainty will be tested this year.
However, it’s not all doom.
“US companies just proved themselves to be very resilient to a lot of uncertain developments during and after the pandemic,” she said. “So I wouldn’t count them out. There are a lot of battle-tested risk managers across many sectors. They’re going to definitely have a busy year, but that doesn’t mean that it’s automatically going to be the worst outcome that manifests itself.”