Growth challenges are mounting while tariffs will lift inflation, but stagflation fears are wide of the mark. The Fed will likely delay rate cuts until the end of the year, despite escalating pressure from the president, but may move in larger steps when it does cut
Consumer Caution Weighs on Growth
2025 and 2026 consensus forecasts for growth have fallen from 2.2% to 1.5% since the start of the year, with the consumer at the heart of the problem. Sentiment has soured and this has led to consumer spending plateauing over the past six months after having been the engine of growth since the end of the pandemic.
The reasons for this are threefold. Firstly, households quickly recognised that they would be the ones to pay the bulk of the tariff cost despite President Trump declaring that it would be foreigners who pay. With a renewed hike of tariffs on many key trading partners in recent days, the sense that tariff-induced price hikes will squeeze spending power will remain front and centre in consumers’ minds.
Real Consumer Spending Levels Highlight The Lack Of Growth Since December (December 2024 = 100)
Source: Macrobond, ING
Corporate Sector Hurt by Lack of Trade Clarity
At the same time, there is a perception that the jobs market is weakening more significantly than official data suggests. Outside of the private education and healthcare services, government and leisure and hospitality sectors, job creation has virtually stalled and has actually fallen in nine of the past 30 months. Meanwhile, the pick-up in Worker Adjustment and Retraining Notifications (most larger companies have to give 60 days’ notice of upcoming large job losses) suggests that we need to be braced for the threat of increasing numbers of lay-offs and a renewed rise in the unemployment rate through the second half of the year.
Third, the volatility in household wealth is proving to be unsettling. Equities have since regained their 20% losses earlier in the year, but now it is house prices, the largest store of wealth for most Americans, that is becoming an issue. A lack of affordability is now being met by rising inventory for sale, with two consecutive months of price falls already.
This leaves the corporate sector in an uncertain situation, with tariffs and trade further clouding the outlook. This is leading to more subdued investment spending with residential investment looking particularly vulnerable given what is happening to home prices. Second-quarter GDP growth will be lifted by a large unwind of the first quarter import surge caused by businesses front-running tariffs, but that could reverse again in the third quarter, given President Trump’s renewed push for higher tariffs on key trading countries from 1 August.
Tariff-Induced Inflation Will Set Up a Big Clash Between the President and the Fed
Inflation has been well behaved in recent months, posting 0.1% and 0.2% month-on-month readings, but we always suspected it would be three months from April/May before the tariffs show up. That means the July, August and September reports are where we will see the potential 0.4% MoM or even 0.5% prints. President Trump has been pushing the Fed to cut rates by 200bp to 300bp immediately, and two of his appointees to the FOMC from his first presidential term suggested they could vote in favour of a cut as soon as the July . However, the rest of the committee feels they have time to wait, especially in light of the recent firmer-than-expected June jobs report.
The Fed was stung by criticism after suggesting the post-pandemic supply shock price hikes would be “transitory”, only for inflation to hit 9% in 2022. We suspect a majority of FOMC members will want to ensure that tariffs are a one-off price change rather than something that leads to greater permanence in inflation. We doubt they will have enough evidence to be certain of that by the September FOMC meeting, so we would need to see some significant weakness in jobs to trigger a rate hike at that point. That suggests the president’s frustrations with Jerome Powell will intensify, with him set to seek a more dovish replacement for when Powell’s term as Fed Chair ends early next year. Talk of firings may escalate too.
Fed to Wait, but Cut by 50bp in December
Nonetheless, will come. The cooler growth environment with a softer jobs narrative and weakening wage pressures will help ensure that inflation is indeed temporary. Moreover, the shifting dynamics of the housing market will mean housing costs, which have been a major driver of inflation in recent years, will increasingly become a source of disinflationary pressure. With the risk that unemployment does start to climb, we believe the Fed will be much more comfortable with cutting interest rates from the December FOMC meeting, kicking off with a 50bp move.
Our main takeaway in our separate section on the One Big Beautiful Bill Act is that this adds a significant chunk of debt due primarily to making permanent the 2017 Tax Cuts and Jobs Act, but does nothing to boost growth. That’s because the bulk of the legislation merely extends the tax cuts that were due to sunset at the end of this year. Moreover, the additional tax cuts announced (including on tips and overtime) are more than offset by the net spending cuts, largely falling on lower-income households via Medicare and food programmes, plus reduced tax incentives for ESG-related projects. As such, there is a net headwind to growth for 2026 versus 2025 which means that the risks are likely skewed in favour of the Fed having to ease more than we are currently forecasting in 2026, rather than less.
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