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June 10, 2025

When I was a kid, I saw a man walk a tightrope strung several stories high without a safety net. I remember the anxiety I felt with each step he took, fearing he would slip and fall to the cement below. It was simultaneously terrifying and mesmerizing.

That feeling haunted me as I put pen to paper to write about the outlook. The economy continued on its growth path in May, but the trajectory is precarious.

The sentiment data on the economy has weakened more than the hard data. The challenge is determining when and if the two will cross.

Consumer and business attitudes have soured. Measures of economic policy uncertainty have eclipsed the highs hit during the onset of the pandemic in the US and on a global scale. Trade policy uncertainty is driving those increases.

The response has been a toxic mix of panic and paralysis. Those who could, stockpiled inventories and bought ahead of tariffs. Those who couldn’t, moved to the sidelines, waiting for the veil of uncertainty to lift.

The trade deficit widened at its fastest pace on record in the first quarter as imports flooded into the country, only to reverse course at the start of the second quarter. The reversal in the trade deficit in April was the largest on record, as imports plummeted.

A pause in May on the most prohibitive of tariffs on China triggered yet another panic. Much like we saw during the pandemic, supply chains had been scrambled when trade with China resumed.

Ships bringing goods into the country were diverted. Getting them back is costly. Shipping rates jumped at the fastest pace on record in early June as importers attempted to reroute ships to where they are needed.

Disruptions to supply chains are well underway. Some plants have scaled back in response to parts shortages. We shed 8,000 manufacturing jobs in May as those disruptions cumulated.

Those shocks are colliding with higher tariffs to constrain supply, while boosting costs. The disruptions are so large that they are simultaneously prompting hiring freezes and hesitation, while boosting consumer prices. That is seeding fears of stagflation.

This edition of Economic Compass takes a closer look at where the administration is in enacting its policy agenda. The speed and sequencing of policies have been destabilizing; the most costly policy changes are front-loaded. The result is a slowdown in growth with a mild bout of stagflation, which is a period of rising inflation and escalating unemployment.

That has left the Fed stuck on the sidelines, determined to tame any tariff-induced inflation before cutting rates again. The equity market has decoupled from the bond market, as Treasury bonds lose their luster as a global “safe haven.� The dollar is in a similar place. The era of cheap money with no consequences is over. Government deficits and debt matter.

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The president signed 259 presidential documents since Inauguration Day. They include 157 executive orders, 39 memoranda and 63 proclamations. That is a record, as of June 3.

Nearly as many lawsuits have been launched challenging the legality of those actions. That is adding to policy uncertainty.

The policy shifts with the largest immediate effect on the economy are:

• Trade and tariffs.
• Immigration and border security.
• Government efficiency and the federal workforce.
• The budget reconciliation bill, also known as the “One, Big, Beautiful Bill,â€� making its way through Congress.
• Regulatory reform.

Trade and tariffs

Chart 2 shows our estimate of the effective tariff rate over the next three years. Tariffs peak at a little above 20% in the fourth quarter of 2025, the highest rate since the early 1900s:Ìý

• The president wants to make good on his campaign promises to raise tariffs to 60% on China and 10% on the rest of the world. We are close.
• Sector tariffs for semiconductors, pharmaceuticals, copper and lumber are next.
• Staffing shortages and tight timelines are bogging down the pace of negotiations; we are less than a month out from the end of the 90-day pause on the highest tariffs on all but China, Canada and Mexico.
• Some reciprocal tariffs on countries with large goods deficits with the US are expected to be reinstated. Vietnam ranks high on that list.
• Trade tensions with China are in flux. The Treasury Secretary has warned against any quick resolutions.

The effective tariff rate tapers as we move into 2026, as firms get better at mitigating the bite of tariffs. Supply chains are being reshuffled and trade rerouted while efforts to document the domestic content of goods to limit tariff costs are on the rise.

Efforts to repeal the tariffs by individual business groups, the states and Congress have all emerged. The administration has levers it can pull to restore any tariffs that are found to be illegal. The administration is testing the waters with applying tariffs retroactively.

Either way, much of the disruption triggered by tariffs has already occurred. Those are hard to reverse.

Tariffs protect some industries at the expense of others. on the 2018-19 steel and aluminum tariffs reveals that they cost more jobs than they created; the manufacturing sector lost 75,000 jobs for the 1,000 created in the steel industry.

Adding insult to injury, those earlier tariffs led to what is known as “� Industries that suffered the consequences of tariffs lobbied the administration for their own protection from foreign competition. That underscores the nonlinear nature of trade wars and illustrates why they are easier to start than stop.

Chart 3 shows the forecast for the core Personal Consumption Expenditures (PCE) Index, the Fed’s preferred inflation measure. It peaks at 4.3% on a year-over-year basis in the fourth quarter, nearly two percentage points above the level hit in April.

That is more than one-half percentage point above the level we expected just a month ago. The move up reflects the higher peak in tariffs and dollar depreciation.

A recent by the Federal Reserve Bank of New York revealed that nearly three quarters of firms raised prices in response to the initial tariffs; some passed all of the increases on. Only 25% absorbed the cost.

Even more stunning was the speed with which costs were passed on. More than “half of both manufacturers and service firms said they raised prices within a month of experiencing tariff-related cost increases � many within a day or week,� the report said.

The contagion associated with those price hikes was high. “[A] significant share of businesses reported raising the selling prices of their goods and services unaffected by tariffs.�

That’s before taking dollar moves into account, which work with a lag. The dollar has depreciated about 10% against a broad basket of currencies since its peak in early January but remains about 20% overvalued.

Another double-digit depreciation is possible. That would amplify the inflationary effects of tariffs and slow the descent in inflation. The silver lining is the impact on exports, which is to the upside as we get into 2026 and 2027.

Separately, productivity growth tends to suffer during high-tariff regimes. on the Gilded Age, an era known for its reliance on tariff revenues, revealed that productivity growth fell at firms that were most protected by tariffs. That is even though we were in the middle of the Industrial Revolution.

Downside risks: Consumers lack the cushion of fiscal stimulus that they had to absorb price hikes during the pandemic. The loss of those funds, coupled with downside risks to employment, could deal a larger blow to demand, which would blunt the rise in inflation associated with tariffs.

Chart 5 shows the forecast for Treasury bond yields, which have risen with a return of what is known as the term premia. That is the extra amount investors require to hold long-term over short-term debt. Several factors are contributing to that shift:

• Central banks, which tend to hold Treasury bonds to maturity, have reduced their purchases over the last decade.
• The move out of Treasuries and into other “safe assetsâ€� accelerated after Russia’s invasion of Ukraine â€� gold and German Bunds are two examples.
• Individual investors, who tend to be more price sensitive, have filled the void left by central banks. They need to be compensated via higher yields due to concerns about higher inflation and escalating government debt.
• A surge in government debt is flooding the market with new supply, which is pushing bond prices lower and yields higher. (The two move in opposite directions.)
• Concerns about the Fed’s independence have intensified, which raises the risk of more inflation and further erodes the safe haven status of Treasuries.
• The dollar has lost some of its luster as a reserve currency, which has spillover effects for the attractiveness of the Treasury bonds.

That does not equate to “de-dollarization� � there is still no substitute for the dollar as a reserve currency. However, it has lost market share to a basket of other currencies and safe haven assets in recent years. Crypto currencies and stable coins are on that list.

Upside risks: The Senate is expected to push back on many of the cuts in the budget package by the House of Representatives. That could further spook Treasury market investors and push yields higher instead of lower.

The speed, scope and sequencing of the administration’s agenda have left us traversing a high-wire, hoping to avoid a fall. The anxiety and uncertainty about the outlook are about as high as I have ever experienced. It is worse than during the height of the Global Financial Crisis in 2008-09, or the pandemic.

It is hard to imagine how bad the devastation would have been if the Fed and lawmakers hadn’t come together to provide a safety net to cushion the blow of those earlier events. Now it is hard to imagine our political leaders agreeing on just about anything, especially when it comes to efforts to rein-in the federal deficit.

If we fail to put ourselves on firmer financial footing, financial markets could do so for us. That is a fall from grace worth avoiding for the world’s largest economy. Tread cautiously, keep your focus on the horizon; don’t look down. Be kind; pay it forward.