Should we be more concerned about US growth or inflation? Or neither?
14 JUL, 2025
By Arif Husain
- Tariffs and fiscal policy are creating crosscurrents in US growth and inflation, shifting market focus between the two.
- Inflation-protected instruments, such as Treasury Inflation-Protected Securities (TIPS), may benefit from a renewed market focus on inflation.
- The Federal Reserve faces the challenge of balancing economic growth and inflation when setting monetary policy.
Over the past 12 months, the market narrative has swung between concern over US economic growth and worry about inflation. Investors often get caught up in the prevailing consensus narrative, which can quickly lead to crowded trades. This, in turn, can cause abrupt shifts in momentum and volatility as investors rush from one side of the boat to the other.
A Consensus Too Complacent on Inflation
By the end of June, the consensus economic outlook had shifted away from fears that tariffs could tip the US economyinto recession, leaning instead towards a soft landing scenario. But this view is overly complacent about the negative impact on growth from a historic increase in the effective tariff rate—particularly for small businesses—as well as the upward inflationary pressure from tariffs.
Looking beyond the second quarter, when the US economy benefitted from front-loading ahead of tariff implementation, growth prospects become murkier. Our Chief US Economist, Blerina Uruci, expects that the US fiscal package—likely to be enacted this summer—will provide a much-needed boost to an underlying growth rate that has been slowing. She does not foresee a recession in the US, although tariffs are expected to keep growth below trend.
While a major rise in the unemployment rate appears unlikely, the labour market now has thinner buffers against a significant weakening than at any point post-pandemic. There are far fewer job openings per unemployed person than in 2021–2022.
In short, the outlook for growth seems more uncertain. But based on current evidence and the likely fiscal stimulus, a recession does not appear probable.
The Impact of Tariffs on Prices Will Be Significant
Our concern about inflation is higher than the consensus. The impact of tariffs on consumer prices is likely to be greater than markets currently anticipate. Blerina’s calculations show that a broad 10% tariff on US imports would raise headline annual inflation by between 0.5 and 1.0 percentage points. With an effective tariff rate of 15%, the inflation shock could reach 1.5 percentage points.
The crosscurrents of tariffs (upward inflation pressure), US dollar weakness (higher inflation), and potential demand slowdown (lower inflation) are influencing inflation expectations. However, I expect tariff effects to dominate and push inflation higher in the second half of the year, despite moderating services inflation.
Of course, the wild card here is the geopolitical situation in the Middle East, which had a significant impact on energy prices (and headline inflation) in June. It is difficult to predict how the conflict will unfold, but it has undoubtedly raised the floor for oil prices in H2 2025.
An Unstable Balance
All in all, the US economy currently stands in a state of unstable equilibrium. Will growth concerns ultimately prevail, or will inflation worries take centre stage? Or will the market consensus remain fixed on a scenario of decent growthwithout a resurgence in inflation? In my view, the US fiscal package currently being debated in Congress will tilt consensus towards renewed inflation concerns. Tariffs (negative for growth) and fiscal stimulus (positive for growth) are pulling in opposite directions, but both raise inflation risks. Markets will come to acknowledge this in time.
When the consensus begins to focus on inflation, the shift is likely to be abrupt. For now, inflation protection—such as exposure to Treasury Inflation-Protected Securities (TIPS)—appears relatively cheap and would benefit from a market pivot towards inflationary concerns.
The US economy is caught in a delicate balance between slowing growth and rising inflation, driven by opposing forces like tariffs and fiscal stimulus. While recession fears have eased, inflation risks remain underestimated. The Federal Reserve Remains in a Policy Bind
How does the Federal Reserve respond? It’s in a bind, to put it mildly. The Fed cannot fine-tune monetary policy—in terms of rate cuts—to address both the economic weakness and inflation created by the ever-changing trade policies of the Trump administration. The central bank will stay on hold until economic data provide greater clarity.
The Fed’s Summary of Economic Projections released after the June FOMC meeting indicated that policymakers still expect a median total of 50 basis points of rate cuts in 2025. While I believe two 25-basis-point cuts remain possible, persistent inflation makes a single cut more likely. A complete lack of easing this year is also a clear possibility for a Fed that was burned by the inflation surge in 2021 and 2022—so investors banking on a Treasury rally driven by Fed rate cuts may end up disappointed.
The final wild card is the seemingly open race to appoint the next Fed Chair. Any hint of politically motivated dovishness in that seat could certainly spur inflation expectations.
