ÀÖÓ㣨Leyu£©ÌåÓý¹ÙÍø

May 13, 2025

“Oh, thunder only happens when it’s rainin� �

-Fleetwood Mac

In a rare moment of joy amidst the pandemic, a video of a man cruising down the highway on his skateboard while lip syncing to the song “Dreams� by Fleetwood Mac went viral. He said he almost didn’t post it.

Stevie Nicks, who penned the song, recorded her own version; more than 130,000 others followed suit. The hit once again skyrocketed to the top of the charts decades after its debut. It remains the band’s most critically acclaimed and commercially successful song.

The irony is that the lyrics are more about decoupling than coupling. It chronicled her breakup with lead guitarist Lindsey Buckingham and was recorded during one of the band’s most tumultuous eras.

That seems an apt metaphor for the escalation of tariffs and trade tensions between the US and the rest of the world.ÌýThe recent de-escalation with China to lower tariffs from 145% to 30% for 90 days is welcome news. That will help to restart trade between the two countries, but it is unclear whether tariffs will rise or drop at the end of the pause.

Disruptions due to trade have already occurred. The April Institute for Supply Management (ISM) manufacturing report shows the toll tariffs are taking. Higher input prices drove down production for the second consecutive month after a brief reprieve earlier in the year. Every manufacturer in the survey mentioned tariffs as a headwind.

Firms are finding legal as well as illegal work-arounds. Reports of smuggling have picked up much like they did during the Gilded Age, when the US relied almost solely on tariffs for tax revenues. The same was true following the Smoot-Hawley Tariff Act of 1930.

This edition of Economic Compass provides an in-depth look at our baseline forecast, which includes a shallow recession. Economic policy uncertainty in the US has now eclipsed the pandemic. That prompted many firms to defer earnings guidance for the remainder of the year. Efforts to front-run tariffs borrowed economic activity from later this year.

Special attention is paid to how those shifts are likely to affect inflation, Federal Reserve decisions and Treasury bond yields. The Fed is not expected to cut rates until December due to a bout of stagflation, a period of rising inflation coupled with escalating unemployment. That has not occurred since the 1970s, long before the overwhelming majority of the labor force was born.

Consumers hunker down

Chart 2 shows the deterioration in consumer attitudes since the start of the year. The Conference Board Survey of Consumer Confidence fell by 19.3 points over the last three months. A drop of 20 points or more has historically portended a recession.Ìý

Expectations for the future fell to their lowest level in 13 years in April and slipped below the level consistent with a recession.ÌýPeople's assessment of current conditions held up better, which limits the pullback in spending to only one quarter.Ìý

The job market posted a better-than-expected 177,000 jobs in April but cracks are forming. Permanent job losses hit the highest level since October 2021. The ranks of those laid off for 27 weeks or longer jumped; they are now 32% above the level we saw in 2019.

The Job Openings and Labor Turnover Survey revealed that the pace of hiring and quits in March was below that of 2019. Layoff announcements picked up in April. That leaves little margin for error.

Much of the impact of the reduction in federal employees is still ahead of us. Many took buyouts or were put on administrative leave.

Those workers are still being paid and counted as employed. They are not expected to fully roll off the government’s payrolls until later this year.

Federal funding freezes and grant reductions are underway. Many are still being adjudicated. Layoffs for contractors and grant recipients are expected to rise. Job postings for scientific research are plummeting.

The largest employment losses are expected to occur in retail, manufacturing and small business. The official data is particularly bad at gauging large shifts in small business employment.

Turning points for that critical sector show up more upon revisions. That could leave the employment data looking deceptively strong until the third quarter.

Another factor is curbs on immigration, which will take a toll on the supply of workers. Foreign-born workers tend to participate in the labor force at a higher rate. They often fill jobs that domestic workers will not. That could keep a lid on the rise in unemployment.

The cushion in savings amassed during the pandemic has been largely depleted. Those who could afford to buy ahead of tariffs did. Consumer spending surged at the fastest pace in two years in March with spending on vehicles driving those gains.

Vehicle sales remained elevated at the start of April but tapered off as the month wore on. Those gains will borrow from spending as we move into the third quarter.

Wealth effects dissipate while the savings rate rises. That hits higher income households, which now make up a disproportionate share of overall spending. Moody’s estimates that the top 10% of earners account for nearly half of consumer spending.

Chart 3 shows the inflation forecast under the three scenarios. The core personal consumption expenditures (PCE) index strips out the food and energy components. The baseline shows inflation peaking at 3.3% in the third quarter..

Shipments from China have come to a near standstill. That means some store shelves could be empty by late May. Other goods could suffer what is known as “shrink-flation,� when we pay the same for less product.

Firms are more willing to pass along prices to consumers than pre-pandemic. Consumers expect those increases but are not able to absorb as much as they could during the pandemic. The COVID-era cushion on savings has been depleted.

Efforts to mitigate tariffs gain momentum in 2026. Those supply chain shifts alleviate the upward pressure on tariffs in 2026.

Upside risks.ÌýCongress could accelerate fiscal stimulus to offset the toll that tariffs take on the economy, but at the expense of even higher inflation.

The first board position at the Fed will become vacant in January 2026 when Governor Adriana Kugler must step down. The president could nominate one of Chairman Powell’s likely replacements at that time.

The list includes Kevin Hassett, who is the current Chairman of the National Economic Council, Kevin Warsh of the Hoover Institution at Stanford University and Treasury Secretary Scott Bessent. All have been openly critical of the Fed.

Efforts to hasten the pace of rate cuts beyond what is justified by the data would be resisted. Remaining Fed leaders and the bond investors would revolt.

Powell refused to answer whether he would retire and vacate his board position when asked after the May meeting. That is important.

President Harry Truman was furious with Fed Chairman Thomas McCabe for not cutting rates to finance the Korean War. He replaced him with William McChesney Martin, who was wrongly seen as a loyalist.Ìý

Martin later famously likened inflation to a bout of drunkenness on Wall Street. He coined the phrase that it was the Fed’s job to pull the punch bowl just as the party is “really warming up.�

Fed chairs have a long history of defying the presidents who appointed them. They have consistently supported the independence of the institution when challenged.

A notable exception was Arthur Burns in the 1970s, who bent to the political pressure of President Richard Nixon. He is blamed for stagflation and remembered as the worst Fed Chairman on record. (Everyone at the Fed knows who Burns is, even the janitor.)

Upside risks.ÌýCongress could implement shifts in fiscal stimulus to blunt the initial blow of tariffs. Those shifts could delay the descent in inflation.

A man who jumped on a skateboard to get to work turned a song about breaking up into an anthem of hope. That song united us during the darkest days of the pandemic, despite chronicling some of Fleetwood Mac’s most turbulent times. The band managed to stay together, despite never writing another number one hit like “Dreams.�

That seems a good metaphor. Tariffs damage long-held relationships and threaten to diminish the starring role the US plays in the global economy. Some of our trading partners could move forward without us as the flow of trade slows.

That is the opposite of the division of labor that the father of modern economics, Adam Smith, touted in his seminal work “The Wealth of Nations.� Close relationships are an asset, not a hurdle to prosperity, when they are functional. Be kind; pay it forward.