The U.S. economy’s key growth driver faces one of the biggest pullbacks since the depths of the Covid pandemic, while price pressures continue to build, sparking concern about renewed stagflation risks in the early days of President Donald Trump’s administration.
Consumer spending, which directly and indirectly powers around two-thirds of U.S. economic growth, suffered some of the biggest declines in at least three years during the first two months of 2025.
💵💰Don’t miss the move: Subscribe to TheStreet’s free daily newsletter 💰💵
Retail sales in February fell the most in nearly two years, according to Commerce Department data, while a subindex of the Federal Reserve’s preferred inflation gauge, the PCE price index, showed the biggest decline in personal spending since February 2021.
Consumer-sentiment surveys from both the Conference Board and the University of Michigan showed notable pullbacks in recent weeks, with the latter citing tariff concerns from a number of respondents.
Meanwhile, data published Monday by the Institute for Supply Management suggest that manufacturers this month saw the biggest monthly price increases since June 2022. The rises likely resulted from the Trump administration’s threats to place tariffs this week on goods imported from Canada, Mexico and China, the U.S.’s three largest trading partners.
The Atlanta Fed’s GDPNow forecasting tool rolled many of those concerns into its recent update on first-quarter economic growth, which is now estimating a 2.8% contraction for the world’s biggest economy just days after it pegged a 2.3% advance.
Lisa Shalett, chief investment officer and head of the Global Investment Office at Morgan Stanley Wealth Management, sees the current “growth scare” giving rise to concern that a slowing economy will continue to produce faster inflation.
Economic-policy uncertainty prompts stagflation concern
“While some slowing was baked into the soft-landing thesis, policy uncertainty is causing some to contemplate stagflation,” she said. (A soft landing is where an economy’s slowing period ends without edging into recession.)
“The consumer confidence reversal, with key metrics now below pre-election levels, has been particularly notable,” Shalett added. “While we continue to assign low recession odds to 2025, falling confidence and rising uncertainty indexes suggest greater short-term fragility.”
The broader labor market, meanwhile, was rattled last week by the biggest increase in jobless claims in five months, as well as a steady series of headlines detailing layoffs at companies including HP (HPQ) , Starbucks (SBUX) , Southwest Airlines (LUV) , Meta Platforms (META) and UnitedHealth Group (UNH) .
Related: Fed inflation gauge indicates big changes in key economic driver
The Conference Board’s “jobs easy to
get/jobs hard to get” ratio slipped further in February, while the Michigan survey showed that more than half of respondents were expecting higher unemployment over the coming year.
The ISM’s benchmark survey also indicated more uncertainty ahead as tariffs loom not only this week but early next month in the form of so-called reciprocal duties on goods from virtually every other U.S. trading partner in the world.
Bond market reaction: Yields drop sharply
New orders in the survey tumbled the most in three years amid the uncertainty surrounding U.S. trade policy and the likely pullback in consumer spending that sentiment surveys suggest.
“We think that at least some of the earlier increase in the ISM manufacturing index from October to January reflected manufacturers hurrying to complete orders before tariffs are applied, a rush that now seems to be petering out,” said Oliver Allen, senior U.S. economist at Pantheon Macroeconomics.
“We see the manufacturing sector continuing broadly to stagnate over the next few quarters,” he added.
Related: US economy faces hit as uncertainty grips markets
Bond markets wasted no time in reacting to the downturn in the ISM outlook, while largely ignoring the inflationary component of the jump in prices paid. Yields on 10-year Treasurys fell to the lowest levels since early December and were last trading at 4.187%.
At the same time 2-year-note yields, which are linked closely to interest rate forecasts, fell below the 4% mark for the first time since October and were last seen trading at 4.001%.
Impact on Federal Reserve rates
CME Group’s FedWatch in fact is now pricing in at least two quarter-point interest-rate cuts between now and year-end, with the first likely to arrive in June.
However, the Fed will publish fresh growth and inflation forecasts when it meets later this month in Washington. And armed with those new data on consumer spending, the labor market and the impact of tariffs, the central bank could reset the interest-rate outlook over the coming months.
The backdrop of slowing growth, stubborn inflation and tariff uncertainty will likely keep the central bank cautious, argues Jay Woods, chief global strategist at Freedom Capital Markets.
More Economic Analysis:
- Retail sales tumble in January, testing Fed rate cut forecast
- CPI inflation shock hammers Fed rate cut bets for 2025
- Rate cuts and tariffs will weigh on economic reports
“This week’s jobless claims are anticipated to come in at 242,000,” he said. “The trend is climbing slowly higher and that could lead to a spike in unemployment over the coming months.”
“For the Fed, this could be another conundrum as they look for evidence that their dual mandate of lower inflation and steady unemployment is under control,” he added. “This may put a damper on any future rate cuts.”
Related: Veteran fund manager unveils eye-popping S&P 500 forecast
