The US economy is currently experiencing significant challenges. Despite these challenges, it has performed surprisingly well given the high uncertainty regarding tariff policies, and also actually higher tariffs. However, 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 published before the shutdown suggests solid growth, although growth is likely to be lower than in the second quarter. The shutdown will negatively impact economic development in the fourth quarter. In any case, only minimal growth was expected for this quarter. We now anticipate stagnation in the fourth quarter. The US economy remains robust, but currently relies heavily on AI-driven investments and affluent households who continue to consume.
In the second quarter of 2025, the economy still expanded 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 very low. Official data from the Bureau of Labor Statistics are only available up to August. In the summer months, only 88,000 new jobs were created. Most of these gains came from the health care sector. The manufacturing sector continued to lose jobs. During the shutdown, the private alternative from the ADP Research Institute provides data for the US labor market in September and October. These data point to a continued weak labor market. 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 only 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 18 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 in which meager economic growth and somewhat elevated inflation will occur together next winter. In our baseline scenario, the economy will experience stagnation but not fall into a recession. Inflation will first increase 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 2025.
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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