Where does a ‘remarkable’ US economy go from here?

The US economy is pulling ahead of its global peers. Inflation is moderating, and the Federal Reserve is cutting interest rates.

Add in a decrease in unlawful southern border crossings and revved-up domestic production in several critical industries, and they amount to a rough list of Mr Donald Trump’s campaign promises.

It’s a list of economic wins that the President-elect is inheriting in large part because of policies that the Fed and Biden administration have pursued in recent years.

The economy is doing better than most economists predicted a few years ago. Forecasters widely warned that the Fed would seriously harm the economy as it tried to control runaway inflation by sharply raising interest rates in 2022 and 2023. Instead, price increases have come down substantially without a broader implosion. The unemployment rate is low. Consumers are spending.

“The US economy has just been remarkable,” Fed chairman Jerome Powell said during a news conference on Dec 18, after the Fed cut rates for a third time in 2024.

But a variety of risks – some sheer happenstance, some floated by Trump – could interfere with that rosy outcome just as the newly re-elected president takes office.

A Fed risk

Mr Powell’s news conference underscored that one economic wild card is central bank policy, which hinges on the outlook for inflation.

After moderating sharply in 2023 and through much of 2024, price increases have been stickier than expected in recent months. That was one factor that prodded Fed officials to revise their inflation forecasts higher for 2025.

But recent lacklustre progress on price gains is not the only reason to worry about the inflation outlook. One-off shocks have repeatedly pushed up price increases in recent years and remain a concern: For instance, egg prices have been heading up again amid a bout of bird flu.

Economists have also warned that Trump’s own policies could lift inflation.

In particular, the President-elect has promised to slap large tariffs on US trading partners, particularly China, a move that could raise consumers prices for imported goods.

Fed officials do not have a good sense yet of what Trump’s policies will encompass or how much they might add to inflation. But if they push up prices, that could prevent officials from cutting interest rates as much as they would otherwise.

The Fed lowered its policy rate to 4.4 per cent on Dec 18 in its third and final cut of 2024. That is down notably from 5.3 per cent three months ago, but still higher than it was at any point in Trump’s first term. It is unclear how much more the Fed will be able to cut, but it seems all but guaranteed that there will be fewer rate cuts than were expected just three months ago.

Because higher Fed rates help to keep mortgage rates and other consumer borrowing costs higher, rates that linger near their current levels are likely to feel uncomfortable for Americans looking to buy a house or finance a car.

And families are already seeing the early impact on their stock portfolios. Equity prices plunged on Dec 18 as investors braced themselves for a period of sustained higher borrowing costs. The S&P 500 index fell nearly 3 per cent, its worst tumble since August. The Dow Jones Industrial Average fell for a 10th straight day, its longest losing streak since October 1974.

The big picture

At the same time, the Fed’s higher-for-longer rate forecasts are a sign of strength: The economy has shown no signs of cracking under the Fed’s recent policy setting.

“The US economy is just performing very, very well – substantially better than our global peer group,” Mr Powell said this week.

The unemployment rate stands at a historically low 4.2 per cent, albeit slightly higher than its 3.7 per cent level a year ago. Gross domestic product has been growing at a solid clip, even after being adjusted for inflation. Productivity growth has been robust in recent quarters, people are starting businesses, and consumers still expect to spend.

“It’s an economy that adds up to be the envy of the world,” said chief economist Diane Swonk at KPMG US.

The inflation question

While much of the economy’s trajectory hinges on what happens next with inflation and interest rates, the outlook also turns on what economic policies the Trump White House pursues. Economists and Fed officials are particularly focused on what happens with trade.

If tariffs push up consumer prices, the economic moment will be very different from the one that Trump faced during the trade war he initiated in his first administration. Businesses and individuals have got used to ever-rising costs, and might be primed to react by hoarding products or paying more.

“They’re in the context of an economy where the embers of inflation are still smouldering,” Ms Swonk said. “It can rekindle.”

Mr Powell acknowledged on Dec 18 the uncertainty surrounding the policies that Trump might pursue and suggested that the central bank needed greater clarity about what might happen before it could determine its response.

“It’s very premature to try to make any kind of conclusion,” he said.

But Mr Powell nodded to the fact that Fed economists were thinking about the possibilities behind the scenes.

He said some Fed officials had integrated the possibility of policy changes into their economic forecasts for next year, while others had not, and that the unknowns were inspiring a cautious approach among some central bankers.

“It’s not unlike driving on a foggy night or walking into a dark room full of furniture,” Mr Powell said on Dec 18. “You just slow down.” NYTIMES

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