The year started out on a solid footing for the economy and the financial markets were pricing in expectations for sustained economic growth. But a lot has changed since the year’s optimistic opening. The changing fortunes of the bond market tell the tale.
As 2025 began, the benchmark US 10-year Treasury yield was trending up, driven by expectations that inflation would remain “sticky” and economic growth would hold steady if not pick up. Two months later, the inflation outlook hasn’t changed, but the growth outlook has taken a hit.
The reshuffling of macro projections is reflected in the recent rally in the bond market and the slide in stocks. The rotation into bonds is a sign that demand for a safe haven has increased while the appetite for risk via equities has waned. A set of ETFs shows that American shares are now posting a 1.7% loss year to date, based on the SPDR S&P 500 (SPY) while bonds are up, led by long-maturity Treasuries (TLT) with a 3.9% gain.
What changed? In a word, Trump. The president’s radical but muddled implementation of tariffs has had a two-fold effect on the economic outlook. First, sharply raising tariffs lifts the odds of retaliation, which in turn threatens a global trade war. Second, the rapidly changing rules issued by Trump heighten the uncertainty.
“Just a couple of weeks ago we were getting questions about whether we think the US economy’s re-accelerating —- and now all of a sudden the R word is being brought up repeatedly,” said Gennadiy Goldberg, head of US interest rate strategy at TD Securities, referring to recession risk. “The market’s gone from exuberance about growth to absolute despair.”
Even Trump is reluctant to dismiss the recession risk at some point in 2025. Asked on Sunday about the potential for an economic downturn at some point this year, the president said: “I hate to predict things like that,” in an interview. “There is a period of transition because what we’re doing is very big. We’re bringing wealth back to America. That’s a big thing.”
To be fair, there are few, if any, signs that a recession has started or is imminent. This week’s update of The US Business Cycle Risk Report – a sister publication of CapitalSpectator.com – shows that a broad review of business-cycle indicators continue to reflect a growth bias. The caveat is that the published numbers don’t yet reflect the dramatic policy changes unleashed by the White House, so the case for recession still relies solely on forecasts.
Fed Chairman Powell is downplaying the odds of a significant economic slowdown. Speaking on Friday, Powell said he’s not worried about the US economic outlook. “Despite elevated levels of uncertainty, the US economy continues to be in a good place. Sentiment readings have not been a good predictor of consumption growth in recent years.”
Economists, however, see trouble brewing in the months ahead. A Reuters poll last week found that 91% of economists view the odds of a downturn to have increased under Trump’s rapidly shifting trade policies.
“Given this is so uncertain and that there are new announcements every hour or so, it’s kind of unclear what the environment is going to look like. It’s hard to deny the risk of a recession has intensified,” said Jonathan Millar, senior U.S. economist at Barclays in New York. “People are pushing off spending and that feeds through to a drag on growth, or perhaps even declines in growth if it’s strong enough. There’s a risk both in terms of higher inflation and downside for activity.”
A growth slowdown is never welcome, but if one is in progress, it arrives at a time when efforts to tame inflation have stalled. Wednesday’s February report on consumer inflation is expected to show that inflation remained sticky last month.
The combination of slowing growth, if not recession, and inflation that persists above the Fed’s 2% target has inspired forecasts of stagflation lately.
“This thing could get off the rails pretty quickly,” said Tim Mahedy, chief economist at Access/Macro. “This is not at the level of the 1970s or 1980s. But it does have a whiff of stagflation, or a mini-stagcession.”
Treasury yields are the key real-time measure of market expectations to monitor. If rates continue to slide, that would be a clear sign that investors are continuing to lift the odds that a recession is approaching. As for the hard economic data, a confirming signal won’t arrive until the March profile is published, which is a month away. Markets, on the other hand, are already placing their bets.