Summer 2025
The Beacon Outlook: United States
Welcome to The Beacon Outlook
This succinct, quarterly outlook delivers up-to-date analysis of leading indicators driving the national and state economies, including GDP growth, employment, housing and commercial real estate markets, taxable sales, international trade, and more.
HIGHLIGHTS
Ballooning National Deficit
The national deficit has expanded to 8.7% of U.S. GDP, the largest ever seen in a full employment economy. With interest rates up, the cost of simply carrying this debt will cause the deficit to grow.
Consumer Spending Binge
Consumer spending in the United States has jumped to 70% of U.S. GDP, the highest level seen during the run up to the ‘Great Recession’. The spending spree is being driven by excessively high asset values, from home valuations to equity prices.
Federal Reserve Policy
Over the past few years, Federal Reserve policy has left the U.S. economy with large imbalances and is largely responsible for the unruly turns the economy has taken.
How and Why the Next Recession Could Begin
The Trump administration took over a U.S. economy overheated by financial bubbles and government deficits… and one that is increasingly reliant on global capital inflows to support its excessive consumption. Since then, the administration has added more fuel to the fire up to and including the passage of the One Big Beautiful Bill Act, even as its ‘America First’ policies turn off foreign investors. While our short-term outlook has improved, there is a rising probability that the nation could face a sudden economic decompression marked by a declining dollar and another sharp surge in interest rates.
In April, Beacon Economics raised its 12-month recession probability to 30% in our submission to the Wall Street Journal’s Survey of Economic Forecasters. In the decade since we have been contributing to the Journal’s consensus survey this is only the second time we have been so aggressive about the likelihood of a recession; the first time was in early 2020 for obvious reasons. Still, our current probability leaves us relatively optimistic compared to the average 50% probability in the most recent survey. Like other forecasters, our pessimism this spring was generated by the collapse in the stock market following President Trump’s extreme tariff threats.
What a difference a few months make. Things have calmed significantly since the market panic in April as the administration backed away from its most damaging tariff threats and current negotiations suggest more reasonable outcomes. Although consumer sentiment is still well below where it was in December, U.S. equity markets have surged to new highs even as long run interest rates have stabilized. However, the dollar, worrisomely, continues to slowly depreciate and now sits at a post-pandemic low.
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Part of the reason for the returned confidence is that the U.S. economy continues to show stability. The negative growth rate in the first quarter was caused largely by a surge in imports gunning to get in before the tariffs, that have/will/won’t/may/may not ever happen. Real growth will come in at slightly under 3% for the second quarter according to early estimates from the GDPNow model of the Atlanta Federal Reserve. Labor markets remain tight and household disposable incomes continue to rise. Given all this, Beacon Economics has reduced our 12-month recession probability in the Journal’s July survey to 20%.
Whether you believe this ‘calming’ is good news or not depends on how you interpret the causal link between the threatened tariffs and the health of the U.S. economy. There are really two narratives in this regard:
- The standard narrative, seen widely in the media, starts with the idea that the U.S. economy is incredibly fragile because a large share of American households are struggling just to get by. Based on this reasoning, a trade war could have been the straw that broke the consumer camel’s back. As one CNN headline breathlessly announced, “The American consumer is on the ropes. Tariffs—and anxiety—could deliver the knockout blow.
- A second narrative, and the one Beacon Economics favors, starts with the idea that the U.S. economy is not fragile but, in fact, is overheated by government deficits, asset bubbles, and foreign inflows of capital. In this storyline, the trade war was also a threat because it could have popped the asset bubble that is attracting external capital inflows. If the dive in the market had impacted the flow of capital, we would likely have seen a sharp rise in interest rates—and the pressure that would put on public and private spending could have been intense enough to create an actual downturn.
The difference between these two scenarios is important in thinking about the recent calming of trade tensions. In the first scenario, the administration’s backtracking is a welcome relief. But if you buy the bubble scenario, then this is just a temporary reprieve until some other issue eventually surfaces to pop the bubble. And in the meantime, other Trump administration policies are pumping more air into said bubble.
Will the Real Imbalance Please Stand Up?
Recessions are caused by some rapid and sustained structural shift in the pattern of demand within an economy. The metaphor we like to use is the economy as a piece of plastic, bend it slowly and it can take most any shape you want; bend it rapidly and it will snap. The game of predicting a recession can best be called “spot the imbalance” as a distended portion of the economy is subject to just the kind of rapid return to normality that can create recession causing conditions.
The imposition of extremely high tariffs on imports could indeed create a recession in the United States. But Beacon Economics is still of the mind that President Trump will never act out the worst of his tariff threats. And at lower levels, tariffs wouldn’t have that great of an impact. As noted in our last outlook, the U.S. economy is not as trade dependent as many other nations. A 20% across the board tariff on goods would amount to a roughly a $650 billion dollar “tax” on the economy, which would be spread across foreign exporters, domestic business, and American households. If the share hitting U.S. households is, say, $200 billion, that translates to roughly 1% of disposable personal income, which is completely manageable given the strength of U.S. household finances.
This is why Beacon Economics’ recession probability increase is not a direct response to President Trump’s wild policy gyrations. The real issue is that the financial strength of U.S. households has incredibly weak foundations. The record level of prosperity currently enjoyed by U.S. households is a function of two illusions. One is the mirage of higher income due to our massive federal deficit, which is 6% of GDP coming into 2025 and puts the nation on track for another $2 trillion shortfall this fiscal year. Second is the illusion of having higher household net worth than is real given that asset prices might best be described at irrationally exuberant. These issues are all remnants of the Federal Reserve’s imprudent and unwarranted decision to pump $5 trillion in quantitative easing (newly printed money) into the economy in 2020 and 2021.
The fragile part of this situation is how all the federal borrowing is being financed by enormous inflows of foreign capital, money that appears to be chasing the outsized (and unsustainable) returns currently seen in U.S. asset markets. It is this flow of money that has pushed the $US to a 40-year high. In the last two years the U.S. economy has seen a net inflow of $2 trillion in portfolio investments, roughly half the federal deficit. In short, the nation’s economy is on a consumption binge being financed by the rest of the world.
Portfolio investments are what international economists refer to as “hot money” since these flows can depart as rapidly as they arrive. Turn off the flow of foreign money and the U.S. economy will have to start self-financing its deficits, something that can only occur through another sharp increase in interest rates. It also means a drop in the $US that will make imports more expensive and create inflationary pressures within the economy.
We saw a preview of how these imbalances can snap and create turmoil back in March when chaotic announcements of steep new U.S. tariffs rolled out. The equity markets swooned as the specter of a serious trade war loomed. Initially, the bond markets rallied as is typical, and long run interest rates fell as investors fled to the safety of government debt. But by mid-April a different trend had emerged. Driven by global investment fears, the $US weakened sharply, causing a reversal in the bond markets and long run rates to bounce back up.
An administration with a clear vision of the U.S. economy would be trying to let air out of the bubble by increasing interest rates to cool financial markets, while beginning to pay down the national debt through tax increases and spending cuts. Unfortunately, such an administration could never be elected in this age of miserabilism. Both candidates in last fall’s presidential election ran on platforms of “fixing” a lagging economy, rather than cooling an overheated one.
In fact, the Trump administration is moving in the exact opposite direction, with a number of policies that add more heat to the economy. The passage of the ‘One Big Beautiful Bill Act’ could expand the national debt by an additional $4 trillion over the next decade, according to the Committee for a Responsible Federal Budget. And it doesn’t stop there. The administration has backed away from any serious regulation of financial markets, and of course the Trump family has been actively peddling their own cryptocurrencies. On top of it all, President Trump has been hectoring the Federal Reserve into lowering interest rates.
All of this reveals that the intent is to keep pouring fuel on the fire, something that increases the probability of a rapid pop in the future and intensifies the economic impact of such an event. That is not a light you see at the end of a tunnel, it’s a train coming around the bend.
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How Will the End of This Expansion Begin?
The weak link is the degree to which the U.S. economy relies on foreign capital to fund the nation’s deficits. A slowdown in the flow of that capital means higher internal interest rates. But that would just be the first step in how the next recession begins. Until the shock of higher rates pierces the illusion surrounding U.S. household finances, it won’t cause a downturn—especially given how rate insensitive U.S. households currently are (most debt is in the form of a 30-year fixed rate mortgage). Any mechanism for triggering a recession needs to move through other channels. Those drivers could play out at follows:
- A slowing of capital inflows will likely occur along with declining asset prices. This decline in household net worth would cause an increase in the consumer savings rate/decline in consumer spending.
- Hikes in interest rates could cause a sharp pullback in business and residential investment that would shock U.S. labor markets and lead to layoffs, unemployment, and lost income.
- The biggest driver could be the federal government itself. Each percentage point increase in the interest rate paid by the United States for its debt will lead to $400 billion in additional expenditures on interest rates alone, triggering a vicious deficit-expanding cycle. At some point Congress will be forced to stabilize the federal deficit by raising taxes and slashing spending.
Under these circumstances standard economic stabilization efforts won’t be available. The Fed’s hands will be tied because cutting the federal funds rate would cause the $US to depreciate further given the basic relationship between exchange rates and interest rates (referred to as uncovered interest parity). This will push longer run interest rates up and offset any stimulative value on the short end of the curve. And fiscal policy will be unavailable as Congress will be struggling to deal with the exploding deficit—at least in theory.
In our current political environment, it’s also reasonable to assume that the U.S. Congress will simply refuse to seriously cut the deficit despite mounting pressure. This is exactly why, to date, there has been no effort by Congress to close the deficit with reasonable budget choices—the electorate will have none of it. Ultimately this could move the Federal government towards some form of default on its outstanding debt. This could prompt a more dramatic intervention by the Federal Reserve through yet another round of quantitative easing, using newly printed money to finance the government deficit… essentially inflating our way out of the problem.
One would think that this alarming option would be the least likely, given our depth of understanding about monetary economics in the 21st century. But when it comes to false narratives, remember that the Federal Reserve itself, in its quest to maintain political independence, has continued to deny that the overuse of stimulus in 2020 and 2021 had anything to do with the inflation of 2022 and 2023. This is nonsense. Never has any nation expanded its money supply by 40% without seeing a corresponding increase in prices. But the gaslighting is liable to create a narrative space that will allow the Fed to yet again indulge in the use of quantitative easing to reduce the shock of a rapid devolvement in the financial markets driven by the nation’s debt crisis.
What would the long run cost be? Quantitative easing to fund the federal deficit might avoid a recession in the short run but would lead to the kind of sustained inflation that often heralds true, long-run economic and political decline; think Germany in the 20’s, Greece in the 40’s, Argentina in the 70’s, or Yugoslavia in the 90’s. This is exactly what hedge fund manager Ray Dalio was warning about when he said in a recent interview that he is worried about “something worse than recession.” We would like to think of him as another in a long line of ‘miserabilists’, but we’re starting to wonder.
U.S. FORECAST – OUTPUT
U.S. FORECAST – KEY INDICATORS
U.S. FORECAST – INFLATION
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