Economic Pain? Market Concerns About the US Economy May Be Exaggerated

Authored by Daniel Lacalle,

A correction in equity markets tends to generate an immediate negative reaction from citizens, citing political headlines about tariffs and trade as the reasons for equity volatility. However, if markets were scared about the US economy, German and Japanese sovereign bonds would not have declined. Furthermore, at the close of this article, 493 stocks in the S&P 500 are flat in the first quarter despite having reached all-time highs in 2024 and all the negative headlines of 2025.

The Bloomberg US Large Cap Index, excluding the magnificent seven, is flat year-to-date. It seems that we are living a normal correction after a massive bull run in the past five years, coming from expectations of persistent inflation and fewer rate cuts. That is why German and Japanese sovereign bonds, historically the beneficiaries in a risk-off scenario, are weak.

Consensus estimates of recession probability have risen to 30%, which is the same level reached in October 2024 and significantly below the 65% probability expected in April 2023. Furthermore, recession probability in the United States, according to Bloomberg, is currently the same as in the euro area. Deloitte and Coutts predict continued GDP growth in 2025, and the Federal Reserve states that the U.S. economy is expected to grow at around 1.8% this year. Understandably, many investors may be concerned about the headlines and believe that these estimates will be downgraded. However, if we look at leading indicators, the vast majority point to expansion.

The Chicago Fed National Activity Index (CFNAI), which measures U.S. economic activity and inflationary pressures, rose to +0.18 in February 2025, up from -0.08 in January, which indicates that economic activity is higher than its historical trend. Furthermore, the S&P Global U.S. Composite PMI, which measures private sector activity across manufacturing and services, signalled expansion and rose to 53.5 in March 2025, up from February’s 51.6, the strongest growth since December 2024. Not all is positive, because the Conference Board Consumer Confidence Index fell sharply in March 2025, dropping to 92.9, its lowest level in over four years, but far away from the levels seen in previous severe downturns, 87.1 during the pandemic and 26.9 in the 2008 crisis.

Job creation remains strong, and the U.S. March nonfarm payrolls are expected to increase by 133,000, with Bloomberg Economics increasing the estimate to 200,000. Furthermore, 2025 should bring a year of average real wage growth.

What are the main concerns from investors? Cutting spending and tariffs. However, reducing government spending is essential to reduce inflation and slash the deficit. In 2024, government spending rose by 10%, a completely abnormal figure that elevated the federal deficit to almost $2 trillion, leaving the U.S. economy with the worst GDP growth adjusted for debt accumulation since the 1930s. This unsustainable spending and indebtedness path was leading America to a debt and inflation crisis. Inflation was caused by elevated government spending leading to exceedingly high money supply growth and destruction of the purchasing power of the US dollar. The MIT concluded that federal spending was responsible for the 2022 spike in inflation and subsequent increases in government outlays and money supply growth perpetuated the inflationary pressures and created an unsustainable debt problem, with interest expenses rising to close to $1 trillion. With this trend, the US debt to GDP would rise from an alarming current 122.3% to 156% by 2055, according to the Congressional Budget Office. Thus, cutting government spending is essential to reduce inflation and avoid a debt crisis. A slowdown of GDP growth coming from a reduction in government spending is not a negative but a signal of strengthening of the productive economy.

Tariffs are a global concern. 

However, most investors seemed to be blissfully unaware of the enormous trade barriers and tariffs implemented by the European Union or China in recent years. Market participants seemed perfectly happy with rising tariffs and trade barriers against the United States from other nations. In the Trade Barrier Index, India, Russia, South Africa, Brazil and China appear as the worst nations in terms of barriers to trade. Furthermore, the European Union and China impose higher tariffs against the United States than the other way round, according to ING and Bank of America. Furthermore, markets reached all-time highs with Biden maintaining and increasing some of the tariffs that existed when he took office.

Tariffs do not cause inflation, as they do not generate an increase in the quantity of currency or the velocity of money. Tariffs are a tool to level the playing field and address the excessive trade deficit of the United States, which is not caused by competitive and open market means but due to all the barriers lifted against U.S. exporters in other nations. Many countries seem to have a view of free trade that means being able to sell as much as they want in the United States while, at the same time, placing increasingly tough trade barriers against U.S. exporters, including tariffs, legal limitations, and regulatory and fiscal burdens. The U.S. trade deficit has tripled from $43 billion in March 2020 to $131 billion in January 2025.

Markets may be spooked by tariffs, spending cuts and inflation concerns because those may mean less money supply and fewer rate cuts. However, tariffs are a negotiation tool aimed at improving the trade balance. Eliminating barriers and negotiating better terms is positive for all markets. Furthermore, the history of trade negotiations and the use of tariffs have proven to have a much smaller impact on the United States economy than initially feared. The 2016-2019 period also proves it. Furthermore, the United States economy is significantly more dynamic and powerful than many believe. Supply-side spending cuts and debt reduction, tax cuts and balancing trade are not negatives for the economy. They are all essential tools to recover real wages, financial strength, and a thriving productive sector.

Short-term pain for long-term gain.