U.S. exceptionalism: Bending but not breaking

At the turn of the year, we anticipated that momentum from personal consumption and business investment would keep the U.S. economy expanding at trend growth into 2025. However, the recent softness across consumer surveys has concerns and increased the possibility of a more pronounced slowdown than initially envisioned. For the preliminary March print, the Michigan consumer sentiment index fell sharply as inflation expectations rose due to tariff concerns. Business confidence, which improved at the turn of the year on optimism around potential business-friendly policies such as deregulation and corporate tax cuts, has started to erode (Exhibit 1).

However, the softness in the survey data, which is regarded as “forward-looking” and actual hard data, which is arguably “backward-looking” are sending mixed messages. Labor market conditions, for example, remain resilient as real wages continue to trend higher, and 151,000 jobs were added in the U.S. economy last month. However, we could see a more discernible slowdown in consumption activity due to the impact of recent federal policies on tariffs and government cutbacks. To that end, the February retail sales report this week highlighted the slowing expansionary pace of real consumer spending from 2H24.

Meanwhile, business fixed investment could see some improvement in the medium term owing to the structural artificial intelligence (AI) trend and the lagging impact of lower interest rates on actual capital spending. Therefore, our core view remains that of a U.S. economic slowdown, rather than an outright recession. However, complexities arising from uncertainties around tariffs, immigration and federal cutbacks could cause a lingering growth drag and push the U.S. economy towards a recession.

All eyes on policies

While the underlying fundamentals of the U.S. economy remain resilient, the possibility of lingering policy uncertainty delaying investment and consumption could create a drag on the economy.

Tariffs

As shown in Exhibit 2, tariffs on Canada, China and Mexico, as well as steel & aluminum, would push tariff rates from 2.4% in 2024 to nearly 10%, a level not seen in 80 years. Early April remains a key window to monitor the given planned announcements on reciprocal tariffs, new tariffs on the European Union (EU) and possibly another increase in tariffs on China following trade investigations. The impact could be significant, as goods from Canada, China, the EU and Mexico, together constitute roughly 65% of U.S. imports. Early signs of retaliation have been proposed by the aforementioned markets, and a prolonged tit-for-tat retaliation could affect global capital expenditure and sentiment.

Immigration

From an economic standpoint, immigrants contribute to the growth of an economy’s labor force, tax base and consumer demand. Since the inauguration, illegal border crossings have declined significantly, but traditional visa applications have not. The concern is that if the latter slows materially, it could pose a challenge to growth as well as create inflation risks from a tighter labor market. In fact, in an extreme scenario where net immigration falls to zero, the working population could decrease by 800,000 persons a year for each of the next five years.

Government cutbacks

The U.S. employs over three million federal workers, accounting for 1.87% of the civilian workforce. Although the percentage is not high and layoffs so far have not materially affected job numbers, the ripple effects from a drag on demand could be concerning. This has prompted federal court judges to intervene and require rehiring, in an effort to slow the process and reduce disruptions.

In March, U.S. President Trump narrowly averted a government shutdown, which would have caused further disruptions to government services and the federal workforce. Despite the government cutbacks observed, we still expect the overall fiscal policy to be expansionary, with the USD 4.5trillion worth of 2017 tax cut extensions providing a growth boost later in 2026. However, should growth risks become more pronounced, the case for further fiscal stimulus would increase.

What does it mean for the Fed?

Softer growth data and higher inflation expectations are putting the Federal Reserve (Fed) in a tight spot, but we believe the Fed could be shifting to a more dovish stance. The current risks of stagflation stem from a likely short-term spike in inflation, driven by supply-side factors, followed by a period of stagnation due to a pullback in capex and consumption. Thus, we see a Fed biased towards cutting rates likely 2-3 times this year, and possibly much more aggressively if a significant drag on aggregate demand materializes.

Investments implications

The market correction that we have witnessed in recent weeks have been concentrated in equities, particularly in technology stocks in part due to elevated valuations (Exhibit 3). It is worth noting that defensive sectors such as healthcare, consumer staples, and utilities have not experienced such a correction.

While our base case is not a recession, the risk is higher than the 15% average for any given year. Investors should be mindful of being positioned for growth shocks should they materialize. Thus, we continue to emphasize the importance of maintaining diversification. This implies adding value stocks, international equities, and considering fixed income and alternative assets in portfolios.

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