Heading into 2025, the U.S. economy is expanding at a solid pace. While President-elect Donald Trump outlined numerous policy proposals during his campaign, S&P Global Ratings' economic outlook for 2025 hasn't changed appreciably. This is partly because we have taken a probabilistic approach and are assuming partial implementation of campaign promises.

It will take time for changes in fiscal, trade, and immigration policy to be implemented and affect the economy. We outline below our assumptions, under a Trump presidency, that we've considered in this economic forecast update. We plan to update our forecasts, and risks to them, as the picture becomes clearer.

Our annual average real GDP growth forecast for 2025 and 2026 is 2.0% each year (up from 1.8% and 1.9%, respectively). These forecasts follow expected 2.7% growth this year. On a year-end basis, we expect growth to come in at 2.3% in 2024 and 1.9% in 2025, down from 3.2% in the fourth quarter of 2023.

Inflation is likely to be above the 2% target for longer than we previously thought. Probability of a disruption to the Fed's easing bias has risen. We now expect the federal funds rate to reach 3.5%-3.75% by the end of next year (versus 3.0%-3.25% in our September outlook). The Fed's reaction has more to do with ongoing resilience and excess inflation in the system, as well as managing risk related to uncertain inflation expectations. Higher short-rate expectations and term premium mean a higher benchmark 10-year Treasury yield than previously expected over the next couple of years.

Table 1

Risks To Our Forecast

The risk to our baseline forecast comes from President-elect Trump's proposed economic plan if fully implemented. Taken at face value, his proposed plan would add to inflation and dent GDP growth relative to our baseline outlook.

Assuming higher interest rates (as the Fed reacts to higher inflation expectations) and retaliation from trading partners, global financial markets would likely become more risk averse. Meanwhile, erosion of purchasing power from inflation would likely offset the economic benefit of proposed tax cuts, potentially resulting in a net drag on output and job creation.

The consumer price level would be materially higher in the first 12-18 months of tariff implementation--although that would be a one-off shift in prices, rather than an ongoing inflationary effect. The Fed would likely react by slowing its current policy easing, given its experience of 2021-2022 inflation persistency (when it argued supply-side inflation shock would be short-lived).

Our current forecast assumes a steady state 3.5% U.S. 10-year Treasury yield, reflecting a 1.1% real neutral rate, 2% long-term inflation target, and 40-basis-point term premium. The unwinding of central bank balance sheets over the coming quarters is the main factor in the expected increase in the term premium (to roughly 20 basis points higher than today's estimate by the New York Fed's Adrian, Crump, and Moench model).

The risk is that if investor sentiment toward fiscal sustainability sours, the term premium could rise materially and bring unwelcome tightening of financial conditions. On the other hand, the Fed could decide to stop quantitative tightening and embark again on asset purchases to ease such tightening.

Assumptions For Our Economic Forecast Under A Trump Presidency

Our baseline assumes a Republican-led Congress extends the personal tax cuts under the 2017 Tax Cuts and Jobs Act due to expire at the end of 2025. We consider that deficit fatigue (resistance to growing the deficit, especially at full employment) would limit legislators in adding much to the deficit-to-GDP ratio.

Even with a Republican sweep, rolling back President Biden's climate and infrastructure policies could prove difficult, given Republican states have been major beneficiaries of the Inflation Reduction Act (IRA), CHIPS Act, and Infrastructure Investment and Jobs Act. But that doesn't rule out the possibility of partial repeals, particularly for the IRA.

Implicit in our forecast is that peak regulatory pressures on the banking, technology, and fossil-friendly sectors are behind us. Strains on capital outlays (and balance sheets) to meet higher regulatory demands will recede, also leading to lower cost pass-through impulse to final consumers.

We also assume that President-elect Trump will use his presidential powers to impose targeted tariffs on China by raising the bilateral effective tariff rate (weighted average) on Chinese imports to 25% (from estimated 14% currently). The announcement may come within the first 100 days in office, but imposition is likely to begin midway through next year (giving businesses time to plan). The Chinese authorities likely would reciprocate with equivalent higher trade barriers on U.S. exports to China.

We assume that the flow of net immigration gradually falls back to the 2017-2019 average over the next two years.

Economic Activity Indicators Suggest The Economy Is Expanding At A Solid Pace On The Eve Of A Second Trump Term

Real GDP increased at an annual rate of 2.8% in the third quarter of 2024 (advance estimate), following a 3% increase in the second quarter. The growth resulted primarily from increases in consumer spending, exports, and federal government spending.

Nevertheless, recent indicators for fourth-quarter GDP and private domestic final purchases suggested that economic growth may have slowed moderately to 1.6%-2.8% (based on various real-time running estimates of GDP), still led by consumer spending and business investment intangibles. Imports look to have become a bigger headwind to growth.

Real private domestic final purchases--which consist of consumer spending and private fixed investment (a metric for private domestic demand)--posted 3.2% annualized growth in the third quarter, stronger than 2.8% average growth over the first half of the year.

Growth has averaged 2.8% the past nine quarters, which is just about the same average growth during 2017-2019 (the first Trump administration, before the pandemic) (see chart 1). Growth in consumer spending has surprised on the upside, supported by increases in real disposable income and solid household balance sheets. The public sector's contribution to growth has been three times more than the average since 2000.

Chart 1

The resilience of consumers was marked by recent upward revisions to personal income and the saving rate. Stronger income growth looks more supportive of spending capacity, which has caused us to lift our near-term consumption forecast.

Annual revisions of GDP and gross domestic income going back to 2019 were published after our last forecast update (see chart 2). The revisions showed that Americans, on aggregate, have not been spending at the expense of accumulated savings as much as we were led to believe in September, before we published our last forecasts.

Income growth had been understated (see chart 3), leaving a sharply higher saving rate of 5.2% (versus 3.3% before the revisions) of disposable income after spending on goods and services and making interest payments in the second quarter of 2024. This rate is not far below the 6.1% personal saving rate average from 2010 to 2019. By extension, accumulated excess savings had also been underestimated, meaning that they weren't completely depleted in the second quarter.

Chart 2

Chart 3

Retail Sales: A Good Start To The Fourth Quarter

The strong finish to the third quarter puts consumers on track for decent spending in the fourth, but the days of extraordinary leaps are likely behind us. Since the monthly growth rate of real personal disposable income has been lagging the growth rate of consumer spending the past six months, households' aggregate spending is likely to ease in the coming quarters.

S&P Global Ratings expects holiday sales (nominal) growth will slow to about 3% in 2024 from 4.7% last year, which is moderately below the pre-pandemic (2015-2019) average of 3.6% (see "U.S. Holiday 2024 Sales Outlook: Consumers Will Trim Trees And Spending This Season," Nov. 12, 2024). Cost fatigue, especially from higher costs of nondiscretionary services, is likely to curb growth in consumer discretionary spending, including on holiday shopping. Cost fatigue likely means that value proposition is going to drive spending decisions more in the future.

That said, retail sales (nominal) surpassed expectations in October with a 0.4% gain over the month. This provided a good start for consumer spending in the fourth quarter, especially given September's data were also revised to double its original strength.

Auto sales were a big contributor to October overall retail sales. Light-vehicle sales at 16 million annualized units in October were 19% above the third-quarter average.

Nevertheless, if motor vehicles are excluded, retails sales were flat on the month. Sales in the "control group"--which excludes the volatile components of gasoline, autos, and building supplies--fell 0.1% month over month in nominal terms, a sizable deceleration from the upwardly revised 1.2% gain in September. Still, once adjusted for price change, it is less concerning in volume terms, which likely rose by 0.1% month over month.

Residential Construction: Soft Amid Still-High Interest Rates

In contrast to resilient consumer spending, activity in the housing sector has been soft as interest rates remain restrictive despite a 75-basis-point cut by the Federal Reserve. The resale market is in a slump. Affordability is an issue, which is bad for demand.

Meanwhile, new home sales (25% of the overall housing market) have drifted up this year amid the swings in borrowing costs. The increase reflects better affordability conditions in the new home market, which has greater supply than the existing home market. Also, builders are able to offer price incentives for increasingly cost-conscious buyers.

Housing starts and permits have stabilized. Looking past the fall, which was disrupted by weather (in particular, hurricanes in the South), housing starts edged up in October on a three-month moving average basis. Permits have stabilized this year, which is indicative of a likely new neutral achieved.

Nonresidential Construction: Slowing Private Investment, Steady Public Outlays

For nonresidential construction, private investment outlays declined an annualized 0.5% in the third quarter. The computer/electronic/electrical category (spending on plants producing electric vehicle batteries and microprocessors), which has been driving the nonresidential numbers higher for the past three years, fell 8.8% (annual rate) in the third quarter. The decline suggests that this category may have already seen its peak in growth.

Data centers, another closely watched category, increased to a $28.9 billion annual rate in September. It has increased in all but one of the last 16 months. We get the sense there is more growth in the pipeline for data centers, together with added construction in the power sector to come.

On the other hand, public construction outlays continued to provide some offset to the growth slowdown in private construction outlays, rising 5.8% quarter over quarter (annualized) in the third quarter. Public infrastructure spending, a key driver of economic growth over the past two years, increased an annualized 2.5% in the third quarter. While infrastructure spending remains high, a recent flattening (in real terms) means it has likely exhausted its potential as a growth source.

Manufacturing: Still Looking For A Rebound

The U.S. manufacturing sector, as indicated by the Fed's industrial production index and capacity utilization, has been stalled for much of the last two years, with only tentative signs of a rebound. The strike at Boeing (now resolved) and hurricanes Helene and Milton likely dampened activity in the sector. But it is more that. Manufacturers also have a historically elevated amount of inventory and will want to move it before doubling down on increased production.

Business Confidence: Positive Signs But Still Below Historical Norms

Meanwhile, business sentiment measures improved slightly even before the election outcome was known, but they remain well below historical norms.

Although the U.S. manufacturing sector remained in contraction territory at the start of the fourth quarter, S&P Global's Manufacturing PMI (Purchasing Managers' Index) pointed to the downturn easing. Service PMI pointed to continued firm current business activity and solid new orders of future activity.

The NFIB Small Business Optimism Index recorded a moderate improvement in October--a welcome development, though it did little to boost sentiment.

Labor Market: Likely To Return To Trend After A Weak October

The pace of job gains continued to moderate since the beginning of the year, and the unemployment rate has moved up but remained low. The labor market has cooled off from the overheated conditions of 2022/2023 and, by many metrics, looks back to pre-pandemic normal levels.

Temporary disruptions (weather and the strike at Boeing) had a hand in October's weak employment report (see chart 4), but barring any future extraordinary events, we expect job growth to return to trend (125,000-150,000) in the months to come. Other timelier indicators point to a halt in labor market loosening, with job postings (by Indeed) flatlining in recent months (see chart 5). The share of the population ages 25-54 with a job is at a 23-year high at almost 81%.

Chart 4

Chart 5

The unemployment rate, at 4.1%, remains just under the longer-run sustainable estimate. The number of job openings is now just slightly above the number of unemployed Americans seeking work, which is a ratio that is a bit below its level just before the pandemic. Job layoffs, as measured by initial claims for unemployment insurance benefits, remained low through early November (see chart 6).

Still, a rise in continuing claims and a fall in quit rates give us pause (see chart 7). Businesses are reluctant to shed workers but are also less eager to hire them. At the same time, workers are not confident about their job prospects as much as much as they were just 12 months ago. This means that workers who do lose their jobs are finding it harder to get new ones, resulting in a higher number of unemployed people (see chart 8).

The annual rate of average hourly earnings growth has ticked up recently. Annual average wage growth stood at 4.0% in October, up since July, when it was 3.6%.

Chart 6

Chart 7

Chart 8

Inflation: Disinflation Progress Stalled Recently

The core consumer price index (CPI) in October rose by 0.3% month over month for the third consecutive month, suggesting inflationary pressures have not been completely vanished. The 12-month change in the core CPI was 3.3% while the three-month annualized change was 2.9% (see chart 9). The CPI and producer price index (PPI) data imply the Fed's preferred core PCE (personal consumption expenditures) price index rose by a larger 0.3% month over month, with the three-month annualized rate at 3% in October.

It appears that the reduction in the underlying rate of inflation has stalled at 2.5%-3% (see chart 8). Core goods prices rose in October for the second month, and service price disinflation appears to have stalled at more than a percentage point higher than its pre-pandemic normal. Used-vehicle prices jumped 2.7% month over month in October, but the recent stabilization of the Manheim auction price index suggests that increase will not be repeated. Although survey evidence points to core goods prices resuming their gradual decline, it is likely not going to be enough by itself to squeeze out the remaining bit of excess inflation.

Disinflation in services is the best bet for further progress to the Fed's 2% inflation target, but core services disinflation has slowed recently just as unit labor costs have started rising. Similarly, shelter inflation has remained high, although the alternative rent indices suggest it will soon fall further. The price balance between goods and services points to smaller wedge between the two, which suggests that inflation may be settling into a new normal of 2.5%-3% (CPI basis), rather than 2%-2.5%.

Chart 9

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Factors--And Risks--Shaping The Forecast

There are several aspects of the current state of the economy to consider as we think about the incoming administration's policy proposals.

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Immigration, the most important factor in the U.S. economy in the last couple of years, will turn to become a headwind to growth.  Immigration is the reason aggregate demand and aggregate supply both have surprised to the upside. It has helped the economy grow at near 3% while also allowing for labor market tightness to recede. Labor supply, which rose 1.6% on average the last two years, is going to slow sharply in the coming years.

Chart 11

An extension of the Tax Cuts and Jobs Act's personal income tax cuts does not affect our baseline forecast.  Our existing baseline outlook already assumes continuity of 2017 household tax cuts.

We do not anticipate corporate tax cuts from 21% to 15% will meaningfully lift the economy's long-run potential.  Any tax cuts at this stage of the economic cycle (where the output gap is positive) would produce a smaller boost to growth than they would when there is slack in the economy (see chart 12). Fiscal multipliers of growth from greater stimulus are simply smaller at this point in the cycle. The output gap is positive currently (aggregate demand running ahead of aggregate supply), unlike in late 2016 when the economy was recovering to close the output gap.

Conceptually, a lower tax rate would reduce the user cost of capital for some industries and likely lead to higher investment. But history suggests not by much, with lower corporate taxes more likely to boost dividends and stock buybacks than investment. Moreover, the negative growth impact of slower immigration growth (that is, the drag on labor supply growth) could more than offset any marginal positive growth impulse of capital deepening.

Chart 12

Once past its initial response, the global financial market is likely to become cautious (resulting in higher volatility), given the potential policy uncertainties.  Timing matters when it comes to the interaction between tariffs and business sentiment. A boost to business sentiment may be short-lived once tariffs come into view. Global financial markets would likely have a "risk-off" response to tit-for-tat tariffs and more restrictive interest rates, resulting in tighter financial conditions.

Tariffs In Focus

In our baseline, an effective tariff rate on Chinese imports goes up from an estimated 14% to 25% next year. This means the effective tariff on overall imports rises from 2.8% to 4.1%. This is likely to add 0.1-0.3 percentage points to annual inflation in the first year, depending on the amount that's passed through from importers to final consumers.

Our sense is that most of the cost to importers will be passed through, like in the first Trump term. Trump tariffs in 2018 and 2019 led to very little job creation in the tariff sectors, and, in fact, job loss occurred in U.S. manufacturing and in the sectors where retaliation was a factor.

The risk is that the president-elect could impose a 10% universal (from all countries excluding China) tariff on goods imports and a 60% tariff on goods from China. The magnitude of such a sweeping tariff is far in excess of what we saw in the first Trump term.

Chart 13

Universal tariff risk

A 10% universal tariff on all core goods imported into the U.S. could add as much as 1.8 percentage points to the Consumer Price Index (based on share of exposure), triggering a resurgence in inflation between 3% and 4% by mid-2026. Although, in theory, that would be a one-off shift in prices, and inflation could drop back to 2% in 2027.

A universal tariff, by design, would prevent rerouting of trade, and there is a high chance that prices of domestically produced goods will also rise. Supply chains would become more expensive and less productive and competitive in the U.S. than in other countries.

Some of the price impact on end-consumers will be blunted because those prices reflect not just the wholesale cost of the imported good, but also costs for transportation, domestic retail staff, and local sales taxes, among others. Moreover, since suppliers' margins are presently elevated, they'd have room to absorb some of the initial inflationary impact from additional tariffs. Dollar appreciation could also help blunt the impact on prices.

The impact on overall GDP would depend on many factors:

• The response of imports,
• The inflation tax-affected response of consumer demand,
• The scope of domestic production to fill in the void,
• The response of trading partners affecting U.S. exports,
• The extent to which some countries will eventually get exempted (like USMCA partners),
• How that additional tax revenue is used (if revenues raised are recycled into additional subsidies--perhaps to benefit farmers or exporters hit by trading partner response), and
• How the federal reserve's interest rate policy reacts to inflationary pressure.

We think that the overall drag on real GDP versus our baseline forecast could be up to 1 percentage point, including both the real income loss to U.S. households and the hit to American exporters (from retaliation and competitiveness). The Fed could look through it as a one-time price level effect, but given recent experience from the pandemic, it will likely put the brakes on (and perhaps even reverse) its easing bias in response to rising inflation expectations.

60% China bilateral tariff risk

Even though imports from China represent just 13% of total U.S. imports (see chart 14), down from 21% in 2018), the ramifications of a 60% tariff on Chinese goods could be significant. We think a 60% tariff, up from an effective 14% rate, could add as much as 1.2 percentage points to consumer prices. Factoring in the hit to U.S. incomes and American exports, the drag on GDP could be as much as 0.5 percentage points.

Chart 14

A 60% tariff would presumably be applied to both finished consumer goods and intermediate goods for domestic production. The rerouting of supply would help limit the increase in prices for American importers, but this would depend on how aggressive the incoming administration is in preventing such rerouting of Chinese exports through other countries.

In the previous China tariff episode of 2018-2019, the higher costs borne by U.S. importers supported a pivot away from Chinese products. Over this period, the shares of U.S. imports from Asia (excluding China) increased (see chart 15). While this may mitigate the risk from exposure to China, these Asian markets may themselves be dependent on China. As a result, U.S. dependence on China may not have eased as much as it appears.

Chart 15