Is the economy heading for a Trumpcession?

Luke Bartholomew: Hello and welcome to Macro Bytes, the economics and politics podcast from Aberdeen. My name is Luke Bartholomew and this week we are taking stock on the outlook for the US economy. After a period of extraordinarily high policy uncertainty, we're on-again, off-again, tariff announcements, Elon Musk's DOGE --the Department of Government Efficiency -- causing serious disruptions in the federal bureaucracy. And Congress struggling to pass fiscal legislation. So we want to talk about the impact of potential policy changes, the impact they could have on the economy, and also the way in which uncertainty around this policy might already be starting to weigh on activity. Because there has been, in the last few weeks, signs of a quite dramatic turnaround in sentiment amongst firms and businesses. They’ve become much more downbeat on the future. Indeed, some people are talking about the risks of a recession. Or dare I say, a ‘Trumpcession’. So I'm delighted to be joined today by my colleague, James McCann, to help us make sense of all of this. James, thanks so much for joining us.

James McCann: Well, thank you for having me.

Luke: Well, James, look, I think a good a place as any to start is with the recent run of data, what it is currently saying about the state of the US economy, and in particular, that big turnaround in the sentiment data that I alluded to.

James: Yeah, absolutely. And I think we can we can cut this a couple of ways. I think the first lens we can look at it is look through those sentiment surveys where you ask businesses or households how they're feeling, a range of different questions about their intentions and the outlook. And then think a little bit more around the hard activity indicators that underpin what we, how we measure growth. So how is consumer spending unfolding, how are different aspects of business investment unfolding, etc. Kicking off with that, with that sentiment side, I think your characterisation is, is right. It's very, very noticeable that business and consumer sentiment has taken a real hit over the first few weeks of the administration. We see very, very clearly across the PMIs and ISM surveys, in the consumer sentiment, like the Michigan survey and the Conference Board surveys. It's very noticeable that the most recent prints have been seeing reasonably sharp declines. I think there's a few things going on here. I think, first of all, there's probably a bit of give back from the improvement in sentiment that we saw after the Republican clean sweep back in November. So you remember, a lot of the narrative back then was around how this would be a more growth-friendly administration with perhaps focusing more on deregulation and tax cuts, as opposed to things like trade policy. And I think as you started to see the initial action of the administration focus more on that trade side, more around DOGE cuts to different aspects of federal spending and employment, that certainly created a bit of disappointment, or a bit of a, a sticker shock for for households and businesses. And if we look away from the headlines in those surveys, which measure sentiment, a lot of the written responses within those surveys are very explicitly calling out uncertainty around things like trade policy, its impacts on trading relationships, on supply chains, and its impact on on consumer prices, too. I think one really interesting result from that, from the Michigan survey of consumer sentiment, was that we did see very short-term inflation expectations spike, and that might reflect some of the concerns the trade policy might imply, with higher tariff rates potentially pushing up final consumer prices. So I think it's very clear that the sentiment, the vibes around the US economy have shifted and some of that early optimism has has perhaps worsened a little.

Luke: So one natural question then is like how much stock to put in sentiment data, both as an indicator of current conditions and also as a causal driver of future economic activity? And the reason I ask that is, well, several reasons. One, there is this notorious partisan divide in reported sentiment. You know, Republicans reporting much stronger sentiment with a Republican president and vice versa for Democrats. So there's a sense in which political views are somewhat polluting the responses you get to those surveys, and thus they're less attached to the the underlying economics. And sort of related to that, you mentioned the shift in the vibes, but famously, for several years under the Biden presidency, there was the so-called ‘vibe session’, right? The sense that the vibes around the economy were extremely poor, yet the economy itself sort of motored on pretty strongly. And so, again, this sense that sentiment and underlying data might be peeling apart a little bit there. So, on that basis, how much of a signal should we be taking from that kind of data in this highly polarised US society?

James: Yeah, I think it's a good point. And I think we should be careful with, with those data. When we just run some simple models and try and understand how predictive consumer confidence is, of different consumer spending outcomes, we don't find the particularly great degree of predictive power there. Similarly, if we look at some of the business sentiment surveys and try and understand the extent to which they're correctly forecasting activity rates, we tend to find that they're relatively noisy and can give at times misleading signals. So I think we have to take them with a, you know, a dash of caution, especially given that that partisan lens that you, that you highlight. People do feel better or worse under certain administrations based on their political preferences. Does that really affect how they go out and interact with the economy, their spending decisions for businesses, their investment decisions? I'm not, I'm not necessarily so sure. I think there's a sense of, oh, things are much worse for the economy as a whole. But my individual position and my individual business outlook is perhaps changing a little bit less. So maybe some of the vibes we should downplay. I think what's interesting at the moment is that some of those, those hard data as well, has started to be a little bit weak too. And so I suppose the combination of this weak survey data and business sentiment data and then signs of weakness in in Q1GDP tracking is creating quite a fertile ground for people becoming concerned. If we look across those those hard data, I think we can explain away some of it as some some of the weaknesses well. Certainly, if we look at things like housing activity, I think a very cold winter probably explains the weak start to the year. That's probably seeped into different measures of consumer spending as well. We have to remember that consumer spending was on a real tear through Q4, and I think statistical agencies are perhaps struggling to fully account for how consumer spending patterns are evolving over over the holiday season, too. But there's no doubt that there has been some sign of a slowdown in that hard data, too. And I think that the combination is creating this concern that, oh, the vibes are shifting around the economy, and could this be the time when that's actually picking up some more material change? And I'm inclined to not get too alarmed at present, but it's definitely a dynamic that we need to watch very carefully.

Luke: And perhaps the one headline indicator that best captures this sense that, there might be this Q1 slowdown has been, and you mentioned some of the trackers, but famously, the Atlanta Fed does this nowcast where it takes in a variety of different economic data and uses that to try and predict where GDP is going to print. And now, over the last few weeks or so, those have been pointing towards quite a steep annualised contraction in Q1. So how much of a signal should we take from that? I mean are there, you mentioned some of the quirks and weaknesses around the data, but is there anything that's particularly worth noting in that respect? And then given all of that, where's your sense of where the underlying pace of growth currently sits?

James: Yeah, yeah. The Atlanta Fed has definitely been putting a cat among the pigeons a little bit, sort of pointing it at times, not as much at the moment, but at times to a very deep contraction in Q1. I think stripping out some of some of the erratics, it looked like net trade was providing a very significant drag. And I think part of the challenge for that model was, as it got very early indications of Q1 trade and a widening in the US deficit, partly driven by by gold imports, it was marking that down as a major growth shock. Now the BLS deal with with gold slightly differently depending on whether it's for investment or consumption. So I think that in part was overstating the raw data, that the Atlanta Fed nowcast was probably overstating the weakness in in net trade. And then what it's not picking up yet either, is that as firms are importing more, and that's what's been driving this worsening in the deficit, they're probably building up inventories too. So I suspect that that net trade, with that net trade drag that the Atlanta Fed has been penciling in, which has caused a lot of the big sort of downside in the Atlanta Fed over recent weeks and days, I think that's probably overstating things. I think what it is probably more accurately picking up, though, is, is perhaps some sign of a of a moderation in consumer spending. You know, I mentioned earlier that I think there's probably a bit of seasonality and a very weak start to to 2025. I think there's probably a little bit of payback to, probably a little bit of cold weather effect, but it wouldn't be a surprise to see consumer spending start to start to moderate somewhat, especially if the labour market is is continuing to slow. And that's generating less income. Perhaps if households were a little bit more cautious around spending, even if their balance sheets look in relatively good shape. So I do think we're on course for, when we take out those erratics, a more fundamental stepped up in growth. But I'd be expecting that that's been running sort of weak positive, as opposed to any sort of major negative contraction. And I still think the underlying fundamentals, if we look at different parts of business investment, away from housing, they look relatively solid too. So I think it's probably signs of a step down in activity rather than really, really material pot hole in growth that could be very challenging to get over.

Luke: Sure, and of course, the other big context for that step down in growth has been the extraordinarily high degree of policy uncertainty. And frankly, it's been very difficult for those of us whose full-time job it is to keep track of policy announcements, to have a sense of exactly where things stand on various fronts. So it would be great for you just to bring us up to date, starting with the tariff announcements, what's being enhanced there, what's being rolled back, and where do things stand on that front?

James: Yeah, the the the trade policy, the speed, the breadth and the intensity of changes across trade policy have been, have been pretty extraordinary. We're only two months into this new administration, less, and we've already seen, for example, the increase in in tariffs on China match everything that Donald Trump delivered during his first term as president. And of course, he's threatening even even greater increases in China tariffs too, so the speed of the change there has been remarkable. It's it's, he's had a broader focus as well. So we’d have expected China to be in the firing line. I don't think it's been a huge surprise to ourselves or the market. But certainly his willingness to to put tariffs on USMCA trade partners in North America – so Canada and Mexico – I think has been surprising and concerning. Now, of course, there's been a bit of to-ing and fro-ing on that. We had a threat to to raise tariffs 25% on, on all trade, excluding energy imports from Canada. That was rolled back a month ago. The threat was reinstated last week. It was temporarily put in place and then roll back for, for for for major components of those trading relationships that are, that are in compliance with the USMCA trade agreement. So more than that an effective halving of that. So we've seen a huge amount of volatility in the tariff rate between the US and and its nearest trading partners in in Mexico and Canada. And then we've seen a whole load of work putting into place investigations all on on current, on future potential tariff increases. So in particular, looking at different sectoral trade imbalances around autos, pharmaceutical products, semiconductors. And we've also seen the launch of this reciprocal tariff framework, which is the administration looking to match tariffs that export partners to the US impose on US companies, be they direct tariffs or be they indirect non-tariff barriers. And they've cast their net pretty wide about how they think about those non-tariff barriers. So a huge amount of noise, China being as probably anticipated, the main the the, the, the country seeing the largest increase in its tariff rates. But perhaps a surprising focus and degree of to-ing and fro-ing on tariffs between the US and its USMCA trade partners.

Luke: And for those tariffs that did get rolled back, at least temporarily, I mean, do we have a strong sense of the reason for that? Is it lobbying? Is it acknowledgment of quote- unquote mistakes? Is there a sense of the so-called equity market vigilantes at work? You know, this idea that, the Trump administration is quite averse to, to nasty market reactions. So to the extent to which there's selloffs there, that can moderate policy. I suppose the reason I'm asking this, is like, does it give us any clues as to what might ultimately stick in terms of tariffs, if we have a sense of what it is that's motivating part of the reason for the some of the reversals so far?

James: Yeah, I think it's an important question. And I think it's likely that an unwillingness to, to to tolerate some of the potential pain that would be, that would be probably liable to to U.S. companies and the US economy in general, from large tariffs on its, on its two largest trade partners locally, the US, sorry, Mexico and Canada. And I think that was partly, as we saw the tariffs put in place, we did see potentially via via lobbying in the first instance, an initial rollback on on autos and then a broader rollback. So it gives some sense maybe that those particular pain points for the administration, once they are put in place, were were flagged as something that would be especially problematic for for large US auto companies. And, and then those, you know, lobbying efforts increased more, more broadly so that, yeah, perhaps we could see and the administration has been adamant that this is not the case, perhaps we could see some signs that there's an unwillingness to, to actually tolerate some of the side effects from, from, from large tariff increases on your major trade partners, be they through sectoral lobbying, be they through an equity market selloff, or be they through concerns that this will quite quickly feed into to different aspects of the economy, either through consumer price increases or or some sort of growth shock. So I think that you can maybe take a, a tentatively encouraging signal from that. Certainly, our expectation going into the new administration was that there would be a degree of pragmatism around tariff increases, that certainly this would be used as a as a stick with which to threaten countries, trying to extract concessions on, on a range of different issues. But there would be this sense of a, a cost benefit analysis and understanding of the potential downside. Yeah. The, the more concerning interpretation might be that these tariff increases haven't been especially strategic. Certainly putting tariffs on, on, on, on Canada around fentanyl, given the volumes of fentanyl that move from, from north to south of the border are relatively low, it it didn't feel like there was a lot that the administration could potentially gain from, from this issue, and that there weren't very many natural off ramps to, to to the with, with, with essentially a win for the United States to to this agreement. So what you, a more pessimistic take would be that this has been a reset from the administration, realising that strategically it was in a position where it wasn't able to extract the type of concessions it it might want from this issue, it's punted this now until April the 2nd, when they'll unveil a whole range of different, different tariff initiatives, be it around the sectoral investigations, country-level investigations and reciprocal tariff investigations. So a more concerning interpretation could be that they're simply a waiting, and this is a, a forestalling of a future tariff increase and one that will be more strategically minded around trying to to meet different trade objectives.

Luke: Well, as you say, 2nd of April is shaping up to be tariff day where announcements on reciprocal tariffs and other tariffs might start to, become a little bit clearer. So I mean, as things currently stand, what are you expecting in terms of what's going to stick and what we're going to get from that day?

James: Yeah, I mean, the first thing to concede is it's it's really challenging to, to, to forecast them to be, to be certain. But I think we’d anticipate that you'd see action across a few dimensions. I think one, and maybe the area we feel most confident around, is that we expect a further increase in tariffs on on China, potentially another 10% on, on China trade that will probably spin out of the investigation into Chinese trade practices, their compliance with the phase one trade agreement that the US and China signed back during Trump's first term, and which, of course, China didn't meet any of the terms of that agreement, subsequently ignored large, large aspects of it. So I think we can feel relatively confident that China feels like it's still an economy very much in the firing line. And then we have to consider what what should we expect from those two other big tariffs -- buckets, for want of a better word -- the reciprocal tariffs and the sectoral tariffs. In practice we think reciprocal tariffs will be implemented, but we don't think the increase in tariffs will match all reciprocal tariffs used by other economies -- be they tariffs or non-tariff barriers. We do think that a policy of that format would be potentially quite, quite damaging, imply quite a significant increase in the US effective tariff rate. And in many cases, it could be hard for other economies to reverse certain non-tariff barriers, certainly quickly. Things like sales taxes in particular -- so VAT in in Europe is a great example. So we expect those reciprocal tariffs to be most focused on physical tariffs that other economies are practically implementing on on US exports into their economies. And we think even there there's scope for potential agreements and negotiations to to curtail some of the impact of that. So we think potentially there's a quite a decent spike in the effective tariff rate based on that reciprocal tariff action. But we think over time some of it will be rolled back, as you do see individual trading partners potentially reduce their own tariff rates or provide other concessions that mean that the US is happy to to reverse some of that tariff increase. And then on the sector side, we do think there's going to be sectoral tariffs. But I think the key to this will be probably the potential for exemptions. Certainly if the US were to imply high tariffs across things like all autos and pharmaceuticals and semiconductors trade, again that would imply quite a big negative hit to to potentially US growth and potentially push inflation higher as well. So we think there'll be carve outs certainly when when the administration has used sectoral tariffs in the past, it's allowed fairly major carve outs and they've blunted somewhat the impact. So if I try and imagine what that means for the effective tariff rate, it's it's still bringing all those two, all those things together -- a material increase, something that pushes the effective tariff rate, probably close to about 10%, maybe a little bit below. That's up from around 3% at the start of this administration. Very quick progress over a short period of time, but it falls short of the potential upside. If the Trump administration were to follow through on all its threats, that would really see tariffs spike to more than double of that. And indeed back to where they were back in in the 1930s, in what was much more damaging trade policy territory.

Luke: And then not only is there this uncertainty around exactly the tariffs that get imposed and where that brings the effective average tariff rate, but there's also this big debate, uncertainty around the kind of economic shock imposed by tariffs as well. And in some sense, I guess it's pretty straightforward. At least I think it is. That it's an unambiguous negative aggregate supply shot, the kind of thing that weighs on growth and pushes up on inflation at the same time. But the big question is the relative size of those two effects, I think. And that's mediated by a number of factors -- market structure, currency movements, financial conditions, other behavioral responses. So it's not an easy thing to estimate at all. But forgive me then for asking. What is your assessment of that impact? How are you factoring it into forecasts and kind of what is the degree of uncertainty around those estimates?

James: Yeah, I mean, the uncertainty is is high. And it's it's because, if we think of tariffs essentially as a, as a tax, the key question is who ends up paying that, paying that tax. Is it the final consumer buying buying a product? Is it absorbed into the supply chain? So into effectively, corporate margins. Do you see some of the effect of the tariff rate effectively canceled out by big exchange rate movements, which in themselves have broader distributional effects as well? And yeah, we can make assumptions around around all these things. And you can factor in different aspects of the structure of the market. Be it around their degree of competition in the market, where the tariff sits in terms of its closeness to that final consumer, or its its position further back in the supply chain, more in the intermediate sector. So they're all important, important judgments. Our expectation is that, broadly speaking, tariffs represents a growth and an inflation shock. So this sense that yes, as you mentioned through the negative supply shock, you'll have the unpleasant combination of of weaker activity rates as companies are forced down less productive supply chains as relative prices increase. But we'll also see some of it pass through into into consumer prices as well as this, some capacity or limited capacity to fully absorb the scale of some of these tariff increases into margins. The relative impact of that though is important. And do you see something that only has a moderate effect on consumer prices and a larger effect on growth? Or do you see something that is more predominantly an inflation shock? I think that's a an important, an important outcome for the Fed and for other central banks. Indeed, if if one is more powerful than the other than it might lead the central bank down, down different policy paths. So yeah, I think we I think it's not unreasonable to expect there to be a growth and an inflation impact. I suspect that they'll be relatively uniform. So if we imagine the USMCA tariffs, it wouldn't be a surprise to see them take around half a percentage point off of growth and maybe push around 0.6 to 0.8 percentage point onto core PCE, that that would be a ballpark of where those forecasts might be. But based on different modeling approaches, you could you could see those those relative impacts look quite, quite different. So I think we have to be humble. And, you know, similar to what central banks are doing now, we have to almost wait and see how these start to percolate through economies, especially when we combine them with with different policy or different aspects of the administration's policy agenda.

Luke: Well, that's it. Before we talk about the Fed, it might be worth just closing off with, some of the other aspects of the policy agenda, another place as being a huge amount of uncertainty, generated lot of headlines is around DOGE. Arguably it's approaching the federal government with its tech-inspired move-fast-and-break-things kind of attitude. And that's leading to a lot of legal review around some of the changes. And frankly a fair bit of chaos. But the February employment report arguably contained some signs of those job losses starting to show up. So, I mean, do you have a sense of how big those could end up ultimately being both directly through federal job losses, but then also some of the knock on effects of of that weakness spreading?

James: Yes, you're right. The the February payrolls saw federal employment drop by by 10,000. So not an enormous headwind to to overall payroll. But given that we saw that increase by around 5,000 a month on average last year, it is a decent swing. And it's something that suppressed aggregate payroll growth, which is already, given weaker private sector hiring, been slowing over over recent quarters. I certainly think that it's sort of a trend. I think if we look at the different components and how DOGE and other aspects of Trump policy changes are affecting the federal government, then I think we we wouldn't be surprised. I wouldn't be surprised to see, on average, cuts between 10,000 to 20,000 in federal employment over the next 12 months or so. I suspect they'll be very lumpy. In particular, the 75,000 federal employees who took the voluntary redundancy packages offered at the start of this year. They'll probably remain on payrolls until September or October. So that's something that will be lagged and will show up in those payrolls reports. But more generally, we have a a federal hiring freeze. So just alongside attrition, which is likely to be relatively high at the moment given some of the pressures being placed on the federal workforce and given some of the changes to to their terms of employment, particularly around them having to be in the office full time now. And then we have the DOGE job cuts. As you rightly said, some of the legality of that is being challenged. But certainly for those who are on probationary work, they have less legal protection. Those people working in their first year employed by the federal government. And so it's possible that you see at least 100,000 to 200,000 potentially falling within that that one-year notice period and could be could be cut through different, different DOGE initiatives. So I think it will be a relatively persistent, albeit lumpy headwind for for hiring. I think it's something that probably takes around 200,000 off, if not a little bit more, payrolls over the next 12 months or so in in aggregate. Again, that's not something that's transforming the look of the labour market, but the concern for me would be that as you're seeing signs of of perhaps slowing business hiring, and you could argue that all the uncertainty we're seeing could that, could make that hiring dynamic even more cautious in the private sector, then the risk is that you do start to see a little bit more loosening, creeping into the labour market. And of course, that comes with its own risk of kicking off some negative cyclical effects, be it by more consumer, more cautious consumer spending, etc.. So that's something I'm watching and watching carefully. I think it's a, a growing risk. And I think it's something that the Fed will be, will be nervous about when it when it thinks about the risks to the economy.

Luke: So on the Fed then, the market as a whole seems to be making the judgment that everything that we've talked about so far means more monetary easing, more rate cuts from the Fed, the market’s now pricing more than three rate cuts this year. It wasn't that long ago that that number was closer to just one cut. So a pretty material turnaround in in rate expectations over a relatively short period of time. So do you think that's justified given everything going on in the data, the shocks that are incoming and how the Fed has described its reaction function around all of this as well

James: I think it's been perhaps a little bit overdone in terms of that rush to price in a greater degree of Fed easing. That that maybe relates to a couple of things. Maybe it relates to my slightly more sanguine take on some of the weakness in the data, or my sense that some of it is, is overstating the, the underlying weakness. So I think as we move through Q1 and maybe into Q2, slower but but not not stalling growth might be something that gives the market a little bit more confidence that the cycle is is holding up, or at least takes away some of the fears that you might be on the verge of a recession, or a ‘Trumpcession’ as some are trying to, trying to coin it. So I think that's one aspect. And then the other is how does the Fed react, as you said, to, to some of these negative supply shocks, and it puts the Fed in such a difficult position because it it moves against two different, the two different components of its, of its mandate. It raises the risk to its employment mandate but also raises the risk to its inflation mandate. My instinct has been that the Fed will be relatively cautious in the near-term, at least around all of this, and I think that reflects probably the context it finds itself in. I think typically it might be more confident to look through it a negative supply shock, and perhaps offer more support to the economy and think that the inflation aspect will be a transitory increase in prices, and it doesn't need to worry overly around it. I wonder if, having been through just a series of those supply shocks over recent years and the resulting above-target run of inflation, means that it has less scope to be to be offering that degree of support at the moment or to be that, that responsive. I think one thing that's, that's complicating this somewhat and, you know, that instinct will be stronger if we were getting clearer signals from the Fed. I think the Fed, for the moment, just really is looking to, to buy time. So when we when we hear from Powell, he sounds very, very much like he's in no hurry to do anything in the near-term. I'm very keen to see firstly, how the policy environment evolves. So what we get on April the 2nd and then critically, how that how that feeds into the economy, the Fed's own models will be throwing up the types of results that we spoke about, where it's possible that this is more of a growth shock or more of an inflation-centric shock, and that that balance really matters for the central bank. So I think that the Fed for the moment is not showing its hand, especially clearly. And I think part of that is that it's a strategy of wanting to to buy itself a degree of time, feeling that it has, you know, some room to, to sit on its hands. Given the easing it delivered last year and, and the still strong fundamentals it sees around, around the US economy. And I think we'll get clearer signals from, from the Fed once it's had a sense of where policy is going and how that's, that's feeding into the economy. But my instinct is that the market is maybe expecting a little too much, and the Fed will be a bit, a bit more cautious just based on that that concern around the inflation backdrop. But also that, yeah, I do think that the tariffs will create a bit more unhelpful inflation pressure, that disinflation has been bumpier, uneven and further bumps on the road, I think, are probably pushing the Fed to be a little bit more cautious.

Luke: Well whilst the Fed does have time on its side, unfortunately we do not. That is all that we have time for this week. So look, as ever, please do allow me to remind you to like, subscribe wherever it is that you get your podcast if you've not already done so. And then all that remains is for me to thank James for joining me this week and to thank you all for listening. So thank you very much and speak again soon.