Policy shakeups

The US economy grew robustly over the past two years compared to peer advanced economies, buoyed by loosening financial conditions (especially a strong stock market), pro-investment policies rolled out during the Biden administration (CHIPS Act, IRA, IIJA), stellar performance of the digital economy, strong inflows of migration and low household savings. However, it is important to note that this growth over-performance has also been fueled by large but unsustainable fiscal deficits. Noticeable areas of persistent weakness have been the housing market, hit by elevated mortgage rates and stretched affordability, and the industrial sector, highlighting the challenges faced by the US economy to re-industrialize.

The pick-up in household confidence in the wake of the elections in November 2024 and loose financial conditions should support activity in early 2025. Meanwhile, the economy will continue to benefit from the Biden administration’s policies. Although the construction spending boom has plateaued, follow-up equipment investment for these factories is likely to accelerate. Other tailwinds for capex growth include growing investment in data centers and hardware equipment. Nevertheless, tight immigration policy and upcoming tariff hikes on imports – with foreign countries expected to retaliate against US exports – will provide some headwinds to US growth. Trade uncertainty will likely hurt corporate sentiment while higher tariffs will be passed on to some degree to consumer prices and corporates’ importing input costs. Tight immigration policy could increase labor shortages in some industries heavily reliant on foreign labor, such as farming, construction, food preparation and healthcare, and weigh on aggregate demand.

In 2026, we expect the Trump administration to deliver new tax cuts but the net fiscal boost to the economy should be modest as federal spending will be restrained. Meanwhile, the negative growth effects of some policies – particularly tariffs and immigration – as well as persistently elevated interest rates will take an increasing toll on activity. We forecast GDP growth to dip below trend growth in 2026, but to remain well above that of peers.
Sticky inflation and resilient growth will prompt the Fed to become increasingly hawkish. The labor market is expected to cool further in 2025 but with only a moderate increase in the unemployment rate forecast. Indeed, slowing labor supply, induced by tight immigration policy, should put floor on unemployment. In this context, we see little scope for further easing of monetary policy in the next 18 months. Accordingly, we expect the Fed funds rate to settle in the 4.00-4.25% range over the next 18 months or so. We see the Fed normalizing policy in the second half of 2026 by cutting interest rates down to our estimate of the neutral rate (3.5%) amid lower growth and cooling inflation.

Corporate bankruptcies have been on a firm upward trend since 2022, though they remain contained relative to historical averages. However, insolvencies of large firms remained way above pre-pandemic levels. Persistently elevated funding costs are straining some US companies. However, other factors are also at play, including a weak industrial sector overall and changing consumer spending patterns. We expect corporate bankruptcies to edge a bit higher in 2025 amid a growth slowdown and prolonged high interest rates. However, solid corporate balance sheets (in particular, high cash buffers and low debt-to-equity ratios) should keep them contained.

Against this backdrop, the US is expected to retain one of the highest rates of medium-term GDP growth potential amongst large developed markets.

The business environment in the US is very accommodating, with the economy consistently ranking amongst the top performers in Ease of Doing Business reports. The hallmarks include strict enforcement of contracts, the ease of resolving insolvencies, the rule of law in general and the easy access to credit. However, politics is becoming increasingly divisive, both between and within political parties. Repeated disagreements over the debt ceiling and the budget have increased economic and political uncertainties. Some of President Biden’s flagship legislation – such as large green subsidies – will be removed or watered down under the Trump administration. However, measures introduced to counter China’s growing influence – such as export restrictions on high-end chips and chipmaking equipment – are likely to be pursued, and even strengthened, amid political consensus to rein in China’s access to western technology. Moreover, the strong policy push towards re-industrialization will continue under the Trump administration, with industrial subsidies likely to be ramped up for sectors such as steel, aluminium and automotives.