The 2.8% contraction in US economic growth that the Federal Reserve Bank of Atlanta is flagging for the first quarter is dreadful news for Asia and the wider global economy.
The Atlanta Fed’s prediction collides with hotter-than-expected inflation in the world’s biggest economy. That, at a moment when Donald Trump seems hellbent on imposing ever-bigger tariffs on US allies and foes alike, exacerbating inflation risks.
Trump’s apparent determination to make stagflation great again comes as Japan also faces an inflation-rising-while-growth-slows quandary. The US following suit greatly ratchets up the stakes for the global financial system.
“A trade war, by definition, is a stagflation shock: Higher prices and lower sales,” says Torsten Sløk, chief economist at Apollo Global Management.
Jeffrey Roach, chief economist at LPL Financial, adds that, for now, tariff-induced inflation amid slower growth could bring the economy dangerously close to stagflation.”
Friday’s US employment report for February is widely expected to show the extent to which US growth is experiencing a sudden downshift.
“Data and events in the coming week could turn these flickers of concern into a real fire,” says Anna Wong, an analyst at Bloomberg Economics.
This week, 10-year Japanese yields rose to 1.5% for the first time since June 2009. This comes as borrowing costs from Germany to Australia surge, too, as governments boost fiscal expenditures to battle growth risks.
In Tokyo, officials including Deputy Bank of Japan Governor Shinichi Uchida suggest rising yields make it less likely the central bank will hike rates as assertively as markets expect.
Yet in China’s case, America’s flirtation with stagflation complicates the outlook for 2025. In particular, China’s ability to meet this year’s recently announced 5% GDP growth target.
As January consumer inflation comes in hot, employers have added far fewer jobs. Unemployment claims were worse than expected this week. The staffing measures in the ISM manufacturing survey, meanwhile, showed a sizable jump in prices paid.
The US falling into a 1970s-like inflationary recession is the last thing Asia needs. Trump’s tariffs will inevitably boost inflation, while uncertainty over his tariff policies will further depress investment needed to hasten growth and increase productivity.
“Perhaps the biggest risk about tariffs is a self-fulfilling slowdown due to corporate paralysis,” says Savita Subramanian, a top Bank of America equities strategist.
Subramanian adds that BofA’s trade uncertainty tracker “continues to hit new records, eclipsing 2018. But earnings transcripts reveal far fewer negative versus we’ve-got-this-style tariff commentary, especially among importers with the benefit of experience.”
Dominique Dwor-Frecaut, chief US economist at advisory Macro Hive, says “Trumponomics has substantial upside, political and economic, but entails substantial implementation risks. For instance, supporting stronger wage gains risks igniting a wage-price feedback loop.”
Managing these risks, Dwor-Frecaut notes, “requires strong competition policy and a strong, independent central bank. Lower energy prices would mitigate these risks by engineering real wage growth with constant nominal wages. Deportations of illegal migrants could shrink the workforce, depress consumption and trigger stagflation if migrants do not work out of fear of deportation.”
Dwor-Frecaut adds that “maintaining a ‘good enough’ equity market performance while shrinking profit income share would require a strong growth rate. Lower energy prices would also help maintain profits and equity performance outside of the energy sector.”
This puts US Fed Chairman Jerome Powell in quite a bind. Trump is demanding lower interest rates, even as his trade policies — and plans for another giant tax cut — militate against Fed easing.
The Fed’s “helicopter money” approach to supporting US consumption is no longer a workable growth strategy. With US inflation risks spooking world markets, demand for US Treasury securities is sure to take a hit.
This directly complicates Trump’s fiscal stimulus ambitions. It also could make it harder for Xi Jinping’s economy to grow at 5%. That target, unveiled at this week’s annual National People’s Congress, is the same as 2024’s growth goal.
It’s a sign that China’s growth model isn’t getting the traction as previously. Trump’s 20% tariff on mainland goods has Team Xi feeling greater urgency to pivot from a longstanding investment-led growth strategy to a consumption-driven one.
On the bright side, Chinese leaders looked quite confident at this week’s “Two Sessions” meeting. At the closely-watched annual event, China adopted a “moderately easy” monetary policy posture to boost consumption. That and hoped for gains in productivity from artificial intelligence, have Xi’s men exuding optimism about China’s 2025.
China, after all, has been battening the hatches to prepare for Trump’s trade war. Still, moves to build a bigger social safety net that incentivizes spending over saving have been slow.
Overcoming tariff risks and domestic headwinds may require more stimulus than markets expect. Earlier this week, Xi’s Communist Party unveiled plans to raise its fiscal deficit to “around 4%” of GDP, China’s biggest since 2010.
The rare rise signals a material shift in Beijing’s stance toward the severity of risks zooming its way. It’s hard not to connect the dots between this increase from 3% of GDP last year and Trump’s escalating trade war.
In October, Chinese Minister of Finance Lan Fo’an said Beijing’s latitude for a deficit increase is “rather large.” A month later, China deployed a 10 trillion yuan (US$1.4 trillion) economic support package aimed largely at helping local governments overcome debt burdens.
China’s property crisis has imperiled a significant generator of revenue for local governments. Meanwhile, Xi’s government is expected to triple the quota for special sovereign bond sales to 3 trillion yuan ($410 billion) this year.
Larry Hu, chief China economist at Macquarie Bank, thinks Beijing will boost the quota for special local government bond issuance to 4.5 trillion yuan ($621 billion) from 3.9 trillion yuan.
The People’s Bank of China, the central bank, has scope to ease further amid weak pricing power in Asia’s biggest economy. Especially with China suffering from deflationary forces. Fears of “Japanification” abound as China lowers its inflation target to 2% from 3% in 2024.
Thus far, the PBOC has been slow to add liquidity out of fear that it might send the yuan tumbling. The central bank also wants to preserve the progress Beijing has made in deleveraging the financial system in recent years.
PBOC Governor Pan Gongsheng worries that cutting rates might incentivize bad lending and borrowing decisions. A weaker yuan might trigger defaults among property developers as they find it harder to make payments on offshore debt. Already, global investors are keeping close tabs on liquidity problems at property developer China Vanke.
Putting yuan internationalization in jeopardy is another concern. For nearly a decade now, Xi’s government has been working to increase the yuan’s use in trade and finance.
Beijing has recently stepped up cooperation with the BRICS — Brazil, Russia, India, China, South Africa — and Global South nations to pivot away from the dollar-centric world order.
Reverting back to the beggar-thy-neighbor policies of the past might alarm international funds and tarnish the yuan’s chances of securing reserve-currency status.
A weaker yuan might have Japan, South Korea and other top Asian economies believing they have a green light to drive down with their currencies to maintain export competitiveness.
That would not go unnoticed by Trump’s White House, which is now threatening the biggest trade war in world history. If the White House concludes Beijing is manipulating the yuan exchange rate, Trump might target China with even bigger tariffs on the scale of the 60% he frequently threatened on last year’s election campaign trail.
Japan also has cause to fear. Corporate Japan is already reeling over hints of a 25% import tax on all foreign-made automobiles.
“Fear of stagflation – due to Donald Trump’s tariffs and other policies – has caused a drop in US interest rates and, thus, a sharp narrowing of the gap” with Japan, says economist Richard Katz, author of “The Contest for Japan’s Economic Future.”
Friend or foe, all in Asia are starting to feel the pain of Trump’s “America First” tariffs.
Follow William Pesek on X at @WilliamPesek
