US Economy Facing "Calculated Decline"
We are playing chicken: the decline will continue until either Trump or the Fed “blinks”
TL;DR
On what became one of the worst trading days of 2025, stock indices suffered significant losses yesterday following confirmation of a new round of aggressive tariffs by President Trump:
Tariff Announcements:
Canada & Mexico: A new 25% tariff, effective Tuesday
China: Tariffs have now risen to a total of 20%—a 10% hike added to the existing 10%.
Immediate Market Reaction (Monday, March 2nd):
S&P 500: Down 1.8%—the worst drop this year.
Dow Jones: Fell by 1.5%, equivalent to roughly 650 points.
Nasdaq: Plummeted by 2.6%, with technology stocks bearing the brunt.
Russell 2000: Declined by 2.8%, indicating that small caps were hit hardest.
Much of the financial press has focused on tariffs, regulatory shifts, and policy uncertainty as the primary drivers of the current economic slowdown. Yet a closer look reveals that a broader deceleration in growth is already underway—one compounded by mounting debt and the Fed's deliberate choice to hold rates steady. The growth scare will continue until either Trump eases tariffs and DOGE cuts or the Fed “blinks” (institutes rate cuts earlier than expected).
Key questions answered this week include:
Questions:
Growth: Will the U.S. maintain high levels of economic growth?
Inflation: Is inflation returning to pre-pandemic levels?
Policy: Will the Federal Reserve deliver the expected rate cuts in 2025?
Answers:
Growth: No. Economic growth is clearly decelerating.
Inflation: No. The evidence strongly suggests inflation has undergone a structural regime shift that will prevent a return to pre-pandemic levels.
Monetary / Fiscal Policy: No - not yet. Persistent inflation will likely limit the Fed's rate cut capacity, with fewer cuts expected than the three currently priced into markets. However, the likely scenario is that the Fed will eventually accelerate rate cuts to prevent a broader slowdown (good buying opportunity).
Conclusion:
The U.S. economy is navigating what can best be described as a calculated decline. With approximately $358 billion in consumer excess savings providing a crucial buffer, manufacturing strength offsetting services sector weakness, and inflation stabilizing at a new (higher) 2.5-3% baseline, we are witnessing a managed deceleration toward more sustainable growth path.
This middle path will likely be characterized by:
Slower but positive economic growth averaging 1-2% rather than the 3%+ rates of recent years
Inflation stabilizing around 2.5-3% rather than returning to the pre-pandemic 2% target
Sector and asset class rotation causing declines rather than uniform market collapse.
The most likely market trajectory involves continued sector rotation through Q2 2025, with technology underperformance offset by strength in value-oriented sectors less sensitive to economic growth (utilities, consumer staples, healthcare) and those benefiting from policy shifts (industrials, defense, energy). The extreme fear readings evidenced by sentiment indicators create favorable asymmetric risk/reward as negative expectations become fully priced in, setting the stage for a potential rebound in beaten-down segments once positioning clears.
Growth
Question: Will the U.S. Maintain High Levels of Economic Growth?
Answer: No. Economic growth is clearly decelerating.
The U.S. economy is pivoting away from the robust growth trajectory of recent years, but this represents a deliberate deceleration rather than an uncontrolled collapse.
Negatives:
GDP Growth Forecasts Revised Downward: Atlanta Fed GDPNow forecast decreased from +3.9% to -2.8% on March 3, 2025. This revision indicates a significant deceleration in projected economic output for Q1 2025, contrasting with Q4 2024 GDP growth of 3.1%. However, this rapid deterioration stems largely from policy-induced adjustments (tariffs / DOGE) rather than fundamental economic collapse.
Projected GDP Growth Rates Subdued: Bloomberg Economics projects US GDP growth to decelerate to approximately 1% by mid-2025. This represents a 60% reduction from the 2.5% growth rate observed in 2024, indicating a substantial moderation in growth.
Policy-Induced Slowdown Intentionally Engineered: Fiscal adjustments targeting a $600 billion annual reduction (DOGE cuts) are projected to reduce GDP by 1-2%, according to Bloomberg Economics. This policy-driven deceleration is designed to moderate inflationary pressures, explicitly prioritizing price stability over maintaining peak growth rates.
Positives:
Manufacturing Resilience: Industrial production increased 2.0% year-over-year in January, while durable goods orders rebounded 3.1% month-over-month to $282.3 billion. This manufacturing strength creates an essential buffer against broader economic contraction.
Consumer Financial Firepower: The approximately $358 billion in excess savings provides an exceptional buffer against economic weakness. As Groen explicitly states in the February 2025 Macro Market Notes, "The stock of excess savings has NOT run out and continues to be a tailwind for consumption. Between December and January, it fell only around $7 billion."
Inflation:
Question: Is Inflation Returning to Pre-Pandemic Levels?
Answer: No. The evidence strongly suggests inflation has undergone a structural shift that will prevent a return to pre-pandemic norms despite economic cooling.
Multiple indicators support this thesis:
Core PCE Inflation Plateaus Above Target: Core PCE inflation at 2.6% year-over-year represents meaningful progress from peak inflation levels but confirms that trend PCE inflation is stabilizing in the 2.5%-2.6% range rather than continuing toward the Fed's 2% target.
Persistent Inflation Expectations: The University of Michigan's survey shows inflation expectations rising to 3.5% in February 2025, remaining structurally higher post-COVID than in 2016-2019.
Rising Labor Costs: The labor share of business revenue is growing at a substantially higher pace over the quarter, creating persistent upward pressure on prices.
Trade Policy Impact: Tariff increases are potentially raising average U.S. tariff rates to 18%, directly increasing costs for imported goods and indirectly raising prices for domestically produced alternatives.
However, this higher inflation baseline does not signal runaway inflation. These structural pressures will eventually moderate and inflation will plateau at 2.5% or so.
Fiscal/Monetary Policy:
Question: Will the Federal Reserve deliver the expected rate cuts in 2025?
Answer: No - not yet. Federal Reserve Chair Powell has pointed to "significant" shifts across tariffs, immigration, fiscal policy, and regulation that have added layers of uncertainty. Yet by choosing not to cut rates in a slowing economy, the Fed is tightening monetary policy passively. Maintaining current rates in a decelerating economy raises real borrowing costs, especially when coupled with rising inflation expectations.
Ray Dalio believes the U.S. can still avert a debt crisis through specific policy actions. The core recommendation is reducing the budget deficit from the projected 7.5% of GDP to approximately 3%, a level where debt would no longer grow faster than the economy. He points to the period from 1992 to 1998, when the U.S. successfully reduced its deficit by 5% of GDP, as evidence this is achievable. Dalio advocates a balanced approach he calls a "beautiful deleveraging," combining deficit reduction (which is inherently economically depressing) with accommodative monetary policy (which is stimulative). I bring it up to suggest that the Fed might eventually “blink” and accelerate rate cuts to prevent a broader decline in asset markets. Upon confirmation of such an event, the wise choice would be to buy the index in size and go along for the ride (hopefully upwards).
Negatives:
Rising Public Debt and Fiscal Deficit: The federal deficit reached $840 billion in the first four months of FY2025—a 58% year-over-year increase—adding to an already high debt-to-GDP ratio.
Treasury Debt Refinancing: In a healthy system, borrowed money creates productivity that generates sufficient income to service the debt. However, when debt grows faster than income, it's like plaque building up in arteries—the debt service requirements crowd out productive spending. This problem compounds as existing debt matures and requires refinancing (about $7 trillion of maturing debt) alongside new debt issuance needed to cover the current budget deficit (approximately 7.5% of GDP). Dalio warns that we're approaching a tipping point where the debt burden becomes unsustainable.
Positives:
Consumer Resilience Buffer: The substantial financial capacity of American consumers, particularly among higher-income households with approximately $358 billion in excess savings, provides an economic buffer that reduces the urgency for immediate monetary stimulus. The concentration of spending power among the top 10% of earners (accounting for 50% of consumption) enhances this resilience
Conclusion: Navigating a Constrained Landscape
While headlines continue to emphasize tariffs and policy uncertainty, a deeper analysis reveals that the real drivers of the current slowdown include mounting fiscal and corporate debt, compounded by a deliberate Fed strategy of passive tightening. The recent market selloff—triggered by Trump's aggressive tariff announcements—only serves to underscore these vulnerabilities.
So what does this mean for markets? The U.S. economy is navigating what can best be described as a calculated decline. With approximately $358 billion in consumer excess savings providing a crucial buffer, manufacturing strength offsetting services sector weakness, and inflation stabilizing at a new (higher) 2.5-3% baseline, we are witnessing a managed deceleration toward more sustainable growth path.
This middle path will likely be characterized by:
Slower but positive economic growth averaging 1-2% rather than the 3%+ rates of recent years
Inflation stabilizing around 2.5-3% rather than returning to the pre-pandemic 2% target
Sector and asset class rotation causing declines rather than uniform market collapse.
The most likely market trajectory involves continued sector rotation through Q2 2025, with technology underperformance offset by strength in value-oriented sectors less sensitive to economic growth (utilities, consumer staples, healthcare) and those benefiting from policy shifts (industrials, defense, energy). The extreme fear readings evidenced by sentiment indicators create favorable asymmetric risk/reward as negative expectations become fully priced in, setting the stage for a potential rebound in beaten-down segments once positioning clears.