The US economy is currently experiencing significant challenges. Despite these challenges, it has performed surprisingly well given higher tariffs and the high uncertainty regarding tariff policies. In the coming months, we expect what we call a mild stagflationary episode, in which meager economic growth and somewhat elevated inflation will occur together.
Due to the shutdown in the U.S., we currently have no data on economic growth in the third quarter of 2025. The available data suggest solid growth. We expect a growth rate of 0.7 percent (2.9 percent annualized). The shutdown will negatively impact economic development in the fourth quarter, although there will be catch-up effects in the remaining weeks (mainly related to government spending that was delayed). In any case, only minimal growth was expected for this quarter. We now anticipate only meager economic growth in the fourth quarter and the first months of 2026. The US economy remains robust, but currently relies heavily on AI-driven investments.
In the second quarter of 2025, the economy continued to expand by 0.9 percent (3.8 percent annualized). Private consumption rose robustly (+0.6 percent), while private investment expanded at a high rate (+1.8 percent). Inventories decreased at the same time as imports significantly dropped. This is due to the fact that, ahead of the higher tariffs adopted in spring, imports surged, leading to temporarily higher inventories. This was reversed in the second quarter. Public consumption was flat in the second quarter of 2025.
Clear signs of weakness now appear. As labor market data show, net job growth was modest. In September, the Bureau of Labor Statistics reported that only 119,000 new jobs were created. This was somewhat higher than in August. Currently, we remain skeptical that this indicates a turning point. It reinforces our view that there will be no recession, but a period of low economic growth and job creation. However, it is important to note that population growth has slowed due to new immigration/emigration policies. The breakeven rate of monthly payroll growth needed to keep up with the labor force has considerably fallen from roughly 165,000 jobs in early 2024 to approximately 85,000 jobs (according to Kolko, 2025) or even as low as 30,000 jobs (according to the Dallas Fed). Discussions about the independence of the Fed and statistical agencies further contribute to uncertainty and a less optimistic outlook for the US economy.
Tariffs have dramatically increased in the past months, and there is still very high uncertainty regarding the further evolution of tariffs. The Yale Budget Lab estimates that the effective average tariff rate is now at approximately 17 percent, the highest tariff rate since the 1930s. In the coming months, inflation will be increasingly affected by these higher tariffs. Weaker demand may somewhat dampen inflationary pressures. Nevertheless, a stagflationary scenario for the US economy is a risk to consider. This puts the Fed into a dilemma. A weaker economy calls for interest rate cuts, while inflation persistently exceeds the Fed target and may further increase again in the wake of tariffs.
We anticipate a mild stagflationary episode, characterized by meager economic growth and somewhat elevated inflation, this winter. In our baseline scenario, the economy will experience very low growth but will not fall into a recession. We expect inflation to remain high in the remaining months of 2025. However, we think inflation will gradually decline in 2026 since the tariff shocks coincide with weak demand and still elevated interest rates. Expansionary fiscal policy and interest rate cuts will help the economy become somewhat more dynamic in 2026, mainly in the second half of 2026. We currently expect one more interest rate cut in December.
Average annual GDP growth will be modest in 2025 and 2026, with growth rates of 1.7% and 1.2%. We expect no recession in our baseline scenario, though the economy will stagnate for approximately three quarters before becoming more dynamic in 2027, achieving 1.8% growth. The unemployment rate will moderately increase in the coming months. Inflation will stay elevated in 2025 and 2026 before approaching the 2% inflation target.
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