American Economy: Stagflation or Recession?

25000400025% 3 11215.14.1%221GDPNOWGDP 20251NBER6410Y Overall Summary: Phenomenon: The US economy has been slowing down both on a macro and micro level, with weakening consumer confidence leading the way and retailers issuing negative guidance. This slowdown has been primarily driven by both "soft indicators" such as the University of Michigan consumer confidence index and "hard indicators" like retail sales and employment data weakening. Analysis: The credibility and sustainability of the US economic slowdown are being questioned, with temporary factors like disruptions in gold imports playing a large role. However, the fading of weather and seasonal disruptions and the decline in bond yields could potentially boost the economic performance in the short term. Outlook: While the likelihood of a recession in the US economy remains low, it is important to monitor risks related to fiscal policy, the stock market, and inflation. The possibility of a recession is still being debated, with various indicators showing conflicting signals. Risks include government layoffs, fiscal tightening, negative feedback loops in the stock market and consumer spending, and inflation risks. Key risk factors to watch for are geopolitical tensions escalating, the US economy slowing down more than expected, and the Federal Reserve turning more hawkish.2) Amazon's performance is also strong, but its forward-looking performance is lower than market expectations. Amazon's fourth quarter online store sales increased by 7.1% year-on-year, exceeding market expectations. Strong holiday shopping season for American residents correspond to the retail performance in the fourth quarter of 2024. However, similar to Walmart, Amazon's forward guidance for first quarter revenue in 2025 is below market expectations.Analysis: Credibility and Sustainability of the Economic Slowdown in the United States? Why is the US economy slowing down? How sustainable is it? According to the above review, the signals of a weakening US economy come from four aspects: consumer spending/consumer confidence, employment data, GDP model economic forecasts, and real estate sales. In general, the weakening of the US economy is mainly affected by four factors: expectations for Trump's 2.0 policy, the cold winter weather in early 2025 in the United States, previous high US bond rates, and stock market volatility. First, trade policy uncertainty suppresses consumer confidence, while weather and stock market volatility weaken consumption. 1) Since November 2024, consumer confidence in the United States has weakened, with trade policy uncertainty possibly being the main cause. Since November 2024, consumer confidence in the United States has weakened, leading to a decline in the Citi US Economic Surprise Index. However, the guiding significance of this indicator for the future weakening of consumer spending in the United States may be limited. On the one hand, consumer confidence does not closely match real consumption data in the United States; on the other hand, consumer confidence is highly influenced by trade policy uncertainty, as also reflected in the University of Michigan Consumer Confidence Report (residents' inflation expectations rise, durable goods purchase willingness declines). 2) "Hard data" on US consumption in January weakened mainly due to a decrease in consumption willingness, rather than income constraints. Retail sales and PCE consumption data in January 2025 weakened significantly, with durable goods falling significantly. Looking at the DRIVE, the growth rate of US household income in January was improving, indicating that income is not constraining consumption, but rather consumption willingness. Early winter weather factors may have had a significant impact on US consumer spending, but online retail sales also weakened, indicating that weather is not the only factor. Uncertainties in tariff policies and significant stock market volatility at the beginning of the year may also have suppressed consumer spending in the United States. Second, weather factors have led to weaker employment data, but the government efficiency department's (DOGE) layoff plan may not have been fully reflected. At the end of 2024, the national development and reform commission emphasized the need to increase counter-cyclical macroeconomic policies. Implementing more proactive macroeconomic policies and prioritizing the expansion of domestic demand and comprehensive reform as key tasks for 2025. Compared to the end of 2023, this meeting of the development and reform commission expressed more positive views on macroeconomic policy, with a clear focus on lifting consumer goods and improving satisfaction with the two heavy and two new aspects, and relevant policies may be further enhanced in 2025. 1) Harsh winter weather had a significant impact on private sector employment in February. In February, the private sector added 140,000 jobs, a slight increase from January, with professional and business services narrowing job losses from 39,000 in January to 2,000. Leisure and hospitality, as well as retail trade, saw job losses of 29,000 and 6,300 respectively, with weather having a major impact on private sector employment, with the Wind Chill Index in the Chicago area dropping to -31.6 degrees Fahrenheit at one point. 2) The impact of Musk's layoffs on employment has not yet been fully reflected. In the employment data for February, the market was more concerned about the impact of Musk's layoffs. According to Challenger data, the US government cut 63,000 jobs in February, with most concentrated in the Washington, D.C. area. However, federal government employment only dropped by 10,000 in February, possibly due to the timing of layoffs falling outside the non-farm sampling period (includes one week with the 12th of the month). Therefore, the impact of Musk's layoffs may continue to be reflected in the next few months. 3) The rising unemployment rate reflects a weakening job market. In February, the US unemployment rate rose to 4.1%, with the labor force participation rate falling to 62.4%. The increase in the number of unemployed individuals came from those completing temporary jobs, with more US residents engaging in part-time work for economic reasons, indicating a weakening labor market and more residents leaving the job market. Thirdly, on February 28, the Federal Reserve's GDPNOW model significantly revised down economic forecasts, mainly due to a surge in gold imports that did not affect GDP. A key catalyst recently causing the market to start worrying about the risk of a "recession" in the US economy is the GDPNOW forecast downgrade. The Atlanta Fed revised its 2025 Q1 economic growth forecast from 2.3% down to -1.5% on February 28, further downgrading it to -2.4% over the past week. Although the downgrade from -1.5% to -2.4% may reflect a weakening in US consumer spending, the primary reason for the downward revision from 2.3% to -1.5% is the "disturbance" caused by increased gold imports. This is mainly due to market concerns about tariffs on precious metals, prompting traders to ship gold and other precious metals to the US, even though most of them are not used in production and thus not included in GDP. Fourthly, real estate sales have remained weak since the end of 2024, mainly due to previous high interest rates and weather. 1) US real estate sales are closely related to the yield on the 10-year US Treasury bond. Before and after Trump's election victory, US bond rates surged, directly restraining sales of new and existing homes, but also indicating that real estate sales may improve after bond rates fall. 2) Similarly to consumption and employment, the real estate sales situation in the US at the beginning of the year was also significantly affected by harsh winter weather, mainly reflected in weak sales of new and existing homes in the southern United States. Outlook: Will the US economy enter "recession"? Is the "recession trade" overheating? The National Bureau of Economic Research (NBER) uses a 6-month frequency indicator to determine the turning point of the economy - differentiating between expansion and recession periods. These indicators include: industrial production index, wholesale and retail actual sales, real personal income (excluding transfer payments), real personal consumption expenditure, non-farm wage employment, and household survey employment. They describe production, sales, income, expenditure, and employment situations, with strong inherent connections between them, such as employment determining income, income determining expenditure, and expenditure, sales, and production being different stages of the economic cycle. As of the end of January 2025, none of these 6 indicators have shown sustained declines, and the probability of an economic recession based on 4 of these indicators is still close to zero (0.26% in January 2005). Essentially, these 6 indicators can be divided into two categories: "income-sensitive" indicators and "interest rate-sensitive" indicators. The former includes real personal income (excluding transfer payments), real personal consumption expenditure, non-farm wage employment, etc.Business and household surveys on employment are related to the labor market situation; the latter includes the industrial production index, actual sales of wholesale and retail, and is highly correlated with interest rates and external demand.The unemployment rate is the "touchstone" of a recession. The United States is a typical consumer economy, and the labor market is crucial for total demand. It is generally believed that the unemployment rate is a lagging indicator of the economy, so using the unemployment rate to judge a recession, while effective, has limited significance for guiding investment. However, precisely because of its lagging nature, it helps to "determine" the turning points in the economy. Empirically, the increase in the unemployment rate is a subset of NBER recessions, meaning that an increase in the unemployment rate is a necessary condition for a recession. The increase in the unemployment rate is "non-linear," but this non-linear change often comes with exogenous shocks. In other words, if there are no exogenous shocks, the increase in the unemployment rate is often temporary or non-sustained, as seen in July 2024 when the U.S. unemployment rate rose to 4.3%, triggering the "Sahm rule," but without any external shocks occurring, the increase in unemployment numbers were found to be related to supply-side or temporary weather reasons. Therefore, it may be a "false recession." Similarly, the decline in the Citigroup economic surprise index is just a normal slowdown. The sustainability of a "recession trade" faces a test. The disappearance of weather and seasonal disturbances and the decline in U.S. bond yields may boost the recent economic performance. 1) The fall in the 10-year U.S. bond yield may provide a certain stimulus to U.S. investment, such as real estate sales - investment, but the manufacturing industry still faces tariff tests; 2) One of the pressures the U.S. economy is currently facing is weather and seasonal disturbances, with the warming weather, U.S. consumer spending, employment, and real estate sales may rebound. What are the risks that the U.S. economy needs to pay attention to in the future? There are mainly four aspects: government layoffs, fiscal tightening, negative cycles between the stock market and consumption, and inflation risks exceeding expectations. In the past few years, the main support for the "exceptionality" of the U.S. economy has been the countercyclical efforts of fiscal policy and the prosperous stock market. Therefore, in the "four major factors" that we mentioned earlier in the weakening of the U.S. economy, Trump 2.0 policy and stock market volatility may be more important risks, more likely to disrupt the logic of the past few years. Whether these 'birth pains' are short-term phenomena as the economy transitions from government support to private sector drive, or will they evolve into larger economic risks, remains to be seen. First, "buyout" layoffs may be reflected in non-farm payroll statistics with a lag, pay attention to local government employment. Currently, there are 75,000 "buyout" layoffs in the U.S. government, who can receive wages until September 30. According to non-farm payroll rules, "buyout" layoffs can still be counted as employment, but will be counted as unemployment after September, creating a one-time shock. In addition, about 220,000 probationary employees may be laid off. If 280,000 people are laid off throughout the year, non-farm payrolls will decrease by 23,000 per month on average, and the annual unemployment rate may increase by 0.18 percentage points. Furthermore, if new employment in local governments is affected, the impact on the U.S. job market will be significant, as this part of employment has become an important support for the U.S. job market in the past two years. Second, if fiscal support is reduced, the growth momentum of the U.S. economy may weaken. Although the layoffs and spending cuts initiated by Musk and the U.S. government have been implemented vigorously, as of January 2025, the U.S. fiscal deficit has risen to 7.3% (rolling), mainly driven by rising statutory expenditures such as healthcare and social security and increasing interest costs, fiscal expenditures continue to exceed seasonal norms. If the intensity of U.S. fiscal measures is significantly reduced after the 2025 fiscal year, it may become a drag on the economy. Third, if the U.S. stock market and U.S. consumer consumption enter a negative feedback loop, significant economic risks may emerge. Equity assets account for the largest proportion of U.S. residents' asset allocation, reaching 36.7% (2024Q3). If we include equity assets indirectly allocated through insurance and pension funds, equities may account for more than half of the total assets of U.S. residents, causing the net worth of U.S. resident sectors to be highly driven by equity assets, thereby affecting the savings rate/consumption willingness of U.S. residents. This is why the U.S. financial markets and U.S. consumer consumption have been able to form a positive cycle in the past few years. However, if the volatility in the U.S. financial markets becomes a long-term phenomenon due to various factors, this positive cycle may be broken, leading to a negative feedback loop. Therefore, the stock market is a major constraint on Trump 2.0 policies. Fourth, the inflationary effects of tariffs may strengthen stagflation risks. Since November 2024, the market has been more concerned about the possibility of "stagflation" brought about by Trump's policies, while significantly overlooking the risks of "inflation." According to the Fed's calculations, if the U.S. imposes a 20% tariff on China and China retaliates with a 10% tariff, U.S. inflation could rise by 0.5 percentage points. If including additional tariffs on Mexico and future retaliatory tariffs, the U.S.'s originally relatively smooth "de-inflation" in 2025 may face significant "re-inflation" pressure, putting the Fed in a dilemma. Based on the current stance of the Fed, Fed officials are not yet worried about short-term economic pressures, but they are concerned about the sustainability of the inflation effects of tariffs. This article is based on a research report published by Shenwan Hongyuan Group; edited by GMTEight: Wenwen.