The start of 2025 has been dominated by uncertainty around tariffs and economic policies, causing significant market volatility. It can be difficult for markets to assess the impact of tariffs because they can be added or removed quickly, and there isn’t always insight into what’s coming next.

Currently, tariffs are set to rise to levels not seen since the 1800s. Some tariffs might be negotiated down, but overall, they are expected to slow growth and increase prices. The estimated impacts on economic growth vary from around 1% to 3% of GDP, with similar levels on inflation.

Business and consumer confidence weakening

This uncertainty around economic and trade policies has made both people and companies less confident. Changes in tariffs, government spending and the impact of immigration policies on the labor market all have contributed to this uncertainty but increases in tariffs have had the greatest impact. Tariffs are expected to increase inflation, slow economic growth, and soften corporate earnings. As policies become more defined, the uncertainty might decrease, but it will likely remain relatively high.

Inflation expectations

Broadly, investors are watching to see how much tariffs create upward pressure on pricing. Then the question turns to how the cost of tariffs is allocated. Tariffs are paid by the importing firm, which can absorb some or all of the increase in price, pass along price increases to the customer, and push suppliers to absorb some of the costs.  

Consumer inflation expectations have risen sharply, with five-year expectations reaching the highest levels since the 1990s. The Fed closely watches inflation expectations because if people expect higher prices, businesses might raise prices, and consumers might demand higher wages, making inflation a self-fulfilling prophecy.

Economic data has been solid but likely softens

Ahead of the tariff announcement consumer spending has remained healthy, supported by steady income gains. Real income, which is adjusted for inflation, remains positive but has declined with moderately higher inflation. More timely data from credit card companies shows resilient spending, especially on services. Spending is somewhat split, however, with lower to middle-income segments softer and upper-income segments strong with growing household net worth. Consumer debt delinquencies have risen but remain relatively low compared to history. Lower to middle-income segments are more stretched, but overall consumer balance sheets are strong with low debt to disposable income.

The U.S. economy has been growing at a solid pace, with a 2.4% growth rate in the fourth quarter of 2024. Underlying data also looks solid, with final sales to domestic purchasers, a broad measure of domestic demand, coming in at 2.9%. However, growth is likely to slow due to tariffs. Bloomberg's broad survey of economists indicates a rising but still relatively moderate recession risk in the next year, with the estimated probability at 30%.  We expect the probability of a recession to rise but maintain our base case view that the economy slows materially but avoids a recession, although the risk of a recession will rise the longer the uncertainty persists. We also expect companies to guide down earnings for 2025 given the uncertainty and impact of tariffs.  Longer-term prospects for earnings growth remain strong. 

Volatility expected to continue

We expect ongoing market volatility as the markets continue to interpret the implications of tariffs and economic policies. The best way to prepare for market volatility is not to be surprised by it. Individuals should have a conversation with their financial advisor to understand how their current financial strategy is positioned to meet their long-term goals. Remember, too, that times of volatility can be potential opportunities, depending on one’s financial goals.