The year 2025 will be an important one for the United States as Donald Trump enters the White House for his second stint as President. The Republican won the election a couple of months back by a landslide margin on the promises of aggressive import tariffs, tough immigration restrictions, re-regulation and smaller government.
As the world’s largest economy in the post-COVID years fought with headwinds like high inflation, not everything was bad. While a section of analysts has been talking about a potential downturn in the world’s largest economy, they have been proven wrong time and time again.
Take the December report for example, where the job gains were much higher than what the roughly 160,000 analysts had expected. American employers added 256,000 workers and the unemployment rate dropped from 4.2% in November to 4.1%. One of the positives of “Bidenomics” was the steady pace in the number of jobs added. In 2024, the tally was 2.2 million, with a monthly average of 186,000.
With a new administration taking over the proceedings, we will talk about what lies ahead for the American economy in 2025.
Where do things stand now?
The US Federal Reserve, charged with keeping both prices and employment stable, cut interest rates for the first time in more than four years in September 2024. While the move boosted hopes of the would-be borrowers in the world’s largest economy, as they were facing the highest borrowing costs in roughly two decades, the latest data on the job market now removes pressure on the Fed to act.
Investors had already been paring back bets on cuts in 2025, worried by signs that the bank’s progress on stabilising prices was stalling. There are also risks associated with policies proposed by Donald Trump, such as extensive border taxes and the deportation of migrants, which could increase prices or wages, thereby exerting pressure on inflation.
The interest rates set by the US central bank have a powerful influence over borrowing costs for many loans, and not only in America. Borrowing costs globally have increased, responding to expectations that American rates are likely to remain higher for longer. Expect the trend to continue for a few months more.
Biden administration’s Achilles’ heel has its over-the-top spending binge. The deficit for the fourth quarter of 2024 has reached a record $711 billion, $200 billion more than for the same period in FY2023-24. Revenues reached only $1.08 trillion and would have to be increased by two-thirds to match spending ($1.79 trillion). There was a decline in corporate income tax ($110 billion instead of $150 billion), while spending soared by more than 10%, or around $176 billion.
This increase leads to a record estimate of the next annual budget deficit, which would reach $1.88 trillion, above the $1.83 trillion of 2023-2024. It is the highest deficit in history (excluding the COVID period), or 6.2% of GDP. Such a figure during a time of growth, full employment and non-deployment of American troops abroad is a major signal that the world’s largest economy is in an untenable fiscal situation.
However, as per Biden’s Council of Economic Advisers (CEA), the country had become a magnet for foreign investment given the resilience of its post-pandemic recovery. The push for new investments in infrastructure, clean energy and semiconductor technology attracted global inflows, especially from close allies including Canada, Japan, South Korea and Britain.
The CEA report also noted the world’s largest economy receiving 41% of global gross capital inflows in 2022-23, the highest share of any country, and nearly doubling its pre-pandemic share of 23%. The dollar also remained the world’s biggest reserve currency and accounted for an outsized share of global trade and cross-border financial transactions.
Under Biden, the US also saw high levels of business investment, one-third of which has gone toward factory construction, thereby resulting in rising productivity and high rates of business formation driven in part by international financing. While total capital inflows remained below the peak of $2 trillion in 2007 just before the global financial crisis, portfolio investment in equity and debt markets totalled a record $1.23 trillion in 2023.
What awaits in 2025?
As per Brian Blank, Associate Professor of Finance, Mississippi State University and Brandy Hadley, Associate Professor of Finance and Distinguished Scholar of Applied Investments, Appalachian State University, the American economy did a great job in 2024 by displaying strong economic growth, moderating inflation, and efficiency gains, amid a global high-interest rate regime.
While the world’s largest economy is expected to continue its positive momentum in 2025, there will be some caveats. Both Blank and Hadley see interest rate cuts as short-term ones, as the policymakers are now bringing things like inflation and unemployment into the play, based on which they will take calls on whether to stimulate the economy or pump the brakes. The interest rate that neither stimulates nor restricts economic activity, often referred to as R* or the neutral rate, is unknown, which makes the Fed’s job challenging.
“However, the terminal rate – which is where Fed policymakers expect rates will settle in for the long run – is now at 3%, which is the highest since 2016. This has led futures markets to wonder if a hiking cycle may be coming into focus, while others ask if the era of low rates is over,” both analysts stated.
While some economists are concerned the recent uptick in unemployment may continue, others worry about sticky inflation. The Fed’s challenge will be striking the right balance, continuing to support economic activity while ensuring inflation, currently hovering around 2.4%, doesn’t reignite.
While GDP growth for Q3 was revised up to 3.1% and Q4 is projected to grow similarly quickly, in 2025 it could finally show signs of slowing from its recent pace. However, Blank and Hadley expect it to continue to exceed consensus forecasts of 2.2% and longer-run expectations of 2%.
The main concern here is the current average effective tariff rate, which stands at 2%. If this rate increases fivefold to 10%, it could cause significant disputes between Washington and its trade allies. Such a change would lead to economic challenges and complicate inflation forecasts.
Blank and Hadley expects tariffs to serve as more of a negotiating tactic for the “Trump 2.0” than an actual policy proposal. Also, stricter immigration policies can also create labour shortages and increased prices, while government spending cuts could weigh down economic growth.
Donald Trump has also promised tax cuts, which may offset some risk and spur growth, especially if coupled with productivity-enhancing investments. However, tax cuts may also result in a growing budget deficit, which is another risk to the longer-term economic outlook.
Talking about the labour markets, hiring rates are normalising, while layoffs and unemployment, 4.2%, up from 3.7% at the start of 2024, remain low despite edging up. The American economy, as per Blank and Hadley, could remain resilient into 2025, with continued growth in real incomes bolstering purchasing power. This income growth has supported consumer sentiment and reduced inequality, since low-income households have seen the greatest benefits.
Overall, the 2025 outlook remains promising, with continued economic growth driven by resilient consumer spending, steadying labour markets, and less restrictive monetary policy. However, higher-for-longer interest rates could put pressure on corporate debt levels and rate-sensitive sectors, such as housing and utilities.
Trump 2.0 and US economy
Trump 2.0 inherited vastly different economic circumstances than the one Republican witnessed while beginning his first term in 2017. Yes, the inflation has slowed down, but hasn’t completely disappeared. Then there are larger federal deficits and higher government borrowing costs than before, and a labour force that has grown faster than expected due to immigration, something he wants to curb.
In 2017, the economy had been growing steadily since the end of the 2007-2009 financial crisis, but the pace was often slow and employment had not fully recovered. There was room for the boost of Donald Trump’s signature Tax Cuts and Jobs Act, and while the import tariffs that followed dealt a blow to the global economy, the United States proved largely resilient.
Inflation was a distant concern during that period, seemingly anchored below the Federal Reserve’s 2% target. Homebuyers could find 30-year fixed-rate mortgages at about 4%, and the government was funding its operations with long-term Treasury bond rates at about 3%. In 2025, inflation is dependent on the Fed’s target, mortgage rates are close to 7%, something which is making the market doubt about whether inflation is contained.
While Donald Trump has created an unofficial Department of Government Efficiency (DOGE) to find savings, there is no plan to address the main drivers of the deficit: the health and retirement benefits for seniors. Key data like employment, inflation, consumer spending and overall growth may not offer much room for improvement without risks.
Analysts’ views on Trump’s road map for American economy are mixed: they see massive tariffs and deportations reigniting inflation and dampening economic growth. Yet they see the Republican’s pledge of expanding the sweeping tax cuts passed in his first term and easing the regulatory burden on businesses potentially juicing the economy.
Forecasters see 2025 as a transition year as the economy continues its post-pandemic recovery but at a lower temperature before Trump’s policies fully take effect. For workers, healthy wage growth is likely to keep outpacing slowing inflation, fuelling consumer spending and job gains. The Federal Reserve’s interest rate cuts, set to continue this year assuming inflation eases further, should provide a boost to growth.
Instead of the recession Moody’s Analytics forecast a few months ago, the research firm foresees a more slowly growing economy in 2025. Donald Trump promised to impose 60% tariffs on Chinese imports and 10% levies on shipments from all other countries to prod manufacturers to move production back to the United States. Recently, he threatened 25% tariffs on Canada and Mexico and 10% fees on China to pressure the countries to curtail the flow of illegal drugs and unauthorised immigration to the US.
By contrast, tax cuts likely won’t stoke growth until 2026 since the tax reform Trump spearheaded in his first term expires at the end of 2025. He and a Republican Congress, however, are expected to extend lower tax rates for all income levels, possibly increase immediate write-offs for business capital investments, and lower the corporate tax rate from 21% to 15%.