US economic activity is starting to falter but the administration’s radical ideas to boost it are contradictory
S&P’s purchasing managers index (PMI) for services fell from 52.9 in January to 49.7 in February, a 25-month low, while consumer expectations for inflation have risen. Signs of headwinds in the US economy come as President Donald Trump seeks to stoke activity through tariffs, tax cuts, energy abundance and deregulation. However, several of his objectives are contradictory and there is little sign of a coherent economic strategy emerging.
What next
Subsidiary Impacts
- Lower US green energy and electric car output will intensify Chinese dominance and could foreshadow West and non-West ecosystems emerging.
- Trump desires a weaker US dollar to make imports costlier but higher rates for longer and investors seeking safe havens will aid the dollar.
- Trump softening his China rhetoric since his inauguration could suggest he sees China as the one global power to rival the United States.
Analysis
Trump’s administration has launched numerous initiatives in its first five weeks, in some cases upending decades of policy orthodoxy. However, there is little clarity over how potential tensions might be managed or resolved.
Trade
Trump wants to prevent foreign industries undermining US jobs and to reshore them where possible. However, the now services-driven US economy is unlikely to transition easily back to sectors which are now less profitable and employ far fewer workers.
Integrated manufacturing production between Canada, Mexico and the United States makes the proposed tariffs especially disruptive (see INT: US tariffs would extensively alter supply chains – February 20, 2025).
Trump suggests that tariffs could raise USD1tn for the US Treasury. However, this is a sales tax on imported goods, paid by US consumers. There are likely to be only a limited number of instances where a foreign supplier will cut their prices to offset the tariff increase.
Tariff revenues are highly unlikely to markedly reduce the budget deficit. If imports are sharply curtailed, import tax revenues will fall.
If higher tariffs succeed in cutting imports, it will limit government revenue
Trump has an expansive view of the purposes that tariffs can serve:
- He threatened 25% tariffs on Canada and Mexico to force them to do more to stop fentanyl entering the United States across their borders.
- His tariff threats to the EU have been coupled with calls for European countries to spend more on defence and, latterly, to reduce value-added tax on consumer goods.
Trump’s mercantilist trade view suggests that tariffs will be mainly applied to the most developed Asian and European economies with large US trade surpluses. This would hit world output by penalising the most efficient countries.
Exports and imports combined make up about 25% of US GDP, making the economic consequences of universal tariffs substantial. Thus US trade policy is likely to be selective (see US: Trump trade policy will look beyond tariffs – November 27, 2024).
Energy
Boosting fossil fuel production and mostly reversing green energy transition policies is central to Trump’s strategy. He has cancelled many Biden administration green energy projects and allowed oil and gas exploration in environmentally protected areas, while also banning new offshore windfarm leases.
He aims to reduce retail energy prices, which many consumers use as a proxy for inflation.
There is a central contradiction. Trump prefers an oil price of USD40 per barrel, to deliver lower inflation and the cheap energy that could super-charge industry and consumption in the United States. However, at that price much shale production is uneconomic. When the Dallas Fed surveyed 200 US oil producers in mid-December, 50% of large firms were investing less this year and 14% expected little change.
Furthermore, OPEC is unlikely to cooperate with Trump’s plan for lowering prices. Many members need an oil price of around USD80 per barrel for budgetary stability.
Most US shale gas production is uneconomic at Trump’s preferred price of USD40 per barrel
Trump’s abandonment of green initiatives is likely to result in US industry — including automobile manufacturers — losing ground in these sectors to their rivals, especially China. Some existing electric vehicle (EV) spending may be ‘stranded’ in ‘out of date’ technologies and processes.
Immigration policy
Trump made the removal of undocumented immigrants a central part of his election campaign.
The labour market impact will be substantial (see US: Immigration policy will intensify labour shortages – February 18, 2025). Foreign-born workers make up nearly 20% of the workforce.
In both agriculture and construction, undocumented migrants account for more than 10% of the workforce. Employment of undocumented workers is concentrated in lower paid jobs. Because the labour market is strong, these jobs are unlikely to attract US workers. The Trump administration has begun high-profile deportation raids but expulsion of all 11 million estimated undocumented persons is unlikely.
The 11-million deportation target is unlikely to be reached
Changes to the H-1B highly skilled migrant visa programme would affect high-tech firms, which have already expressed concern.
Budget
Trump is essentially a ‘supply-sider’ who sees tax cuts stimulating growth.
He is less concerned about budget sustainability. He suggested scraping the US government’s debt ceiling law, but deficit hawks among Republicans in Congress resisted this.
Trump’s priority is lowering taxes, including extending the tax cuts that expire this year. He has indicated there are two ways to pay for this. Neither are credible:
- Tariffs are unlikely to deliver a huge fiscal boost. Research shows tariff costs are largely borne domestically and so his maximalist plans cannot be implemented without causing huge economic harm.
- His plan — outsourced to Elon Musk — to cut the federal budget by USD2tn, or one-third of the total, is impossible given that discretionary spending under Trump’s control is less than USD2tn.
Cuts to federal bureaucracy risk damaging government services. While some businesses will benefit, the cuts could fuel financial market instability, dampen consumer confidence in drugs, food and air passenger safety, and cut competition.
Republicans currently seem to be supporting Trump’s requests on cutting taxes and government spending, which will further fuel financial market concerns.
This matters because, for Trump, the stock market is a key barometer of success. Corporate tax cuts and deregulation could boost profits, particularly for high-tech and finance firms. However, the market is overvalued historically.
Interest rates
Trump seeks lower interest rates to ease cost-of-living pressures and spur consumption and investment, the latter in tandem with deregulation. However, tariffs are inflationary and the rapid growth of federal government debt — projected to double to 200% of US GDP in coming decades — inherent in his fiscal policy is roiling bond markets and increasing interest rates on government debt.
The US Federal Reserve (Fed) is unlikely to deliver the substantial reductions in the headline rate that Trump desires. Three-quarters of traders see one 25 basis point rate cut by end-July. The University of Michigan survey of inflation expectations showed this month that consumers surveyed see inflation averaging 4.3% a year ahead, up from 3.3% last month.
4.3%
Inflation in a year according to the University of Michigan survey, from 3.3% last month
Trump’s desire for lower rates will set him against the Fed. Any challenges to its autonomy will destabilise bond markets and raise concerns about his administration’s economic management.
Outlook
The economy has momentum and is on track for GDP growth above 2%. However, the February services PMI decline — and the University of Michigan and Conference Board consumer confidence indicators edging down, coupled with higher interest rates on US government debt — are especially significant because the US economy relies to a greater extent on services than economies such as Japan or Germany, where manufacturing looms larger. This could prompt Trump to put some of his bolder initiatives on hold, to avoid blame for damaging the US economy.
