The latest economic forecast presents a vivid portrayal of the United States’ economic outlook amid shifting trade policies and corresponding tariff strategies.
The baseline assumption estimates average tariff rates to hover around 15% throughout the forecast period, despite recent court rulings.
Notably, tariffs on imports from Canada and Mexico are projected to decline steadily to about 3% by next year as exporters comply with the United States-Mexico-Canada Agreement (USMCA), thus reducing the effective tariff rate over time.
Simultaneously, a steep 50% average tariff on imports from China persists, coupled with a 20% tariff on the European Union and a 10% rate applied to most other countries.
As the Tax Cuts and Jobs Act (TCJA) nears its expiration at the end of this year, there is an anticipated extension of its provisions, staving off potential tax increases in 2026 while allowing for additional tax cuts to feature in the upcoming budget bill.
While this projected policy is expansionary in nature compared to an alternative where provisions would not be extended, its upside potential for the next fiscal year remains limited relative to the current government’s fiscal stance.
Conditions in the bond market have shifted dramatically, with investors demanding higher yields to lend to the US government resulting in an uptick in long-term interest rates.
The benchmark 10-year treasury yield is expected to remain around 4.5% for the remainder of this year, despite signs of economic softening and an expected 50-basis-point cut from the Fed planned for the fourth quarter of 2025.
A gradual decline in the 10-year treasury yield begins in 2026, with forecasts suggesting a decrease to 4.1% by 2027, maintaining that level through the end of 2029.
Meanwhile, the Federal Reserve’s hesitance to enact swift rate cuts is attributed to the inflationary pressures stemming from tariffs.
The core Personal Consumption Expenditures (PCE) price deflator is expected to be elevated at 3.6% on a year-over-year basis by the last quarter of 2025.
As inflationary pressures prove to be temporary, the Fed can initiate a slow trajectory of rate cuts throughout 2026, with a projected range of 3% to 3.25% for the federal funds rate by early 2027.
Against this economic backdrop, the combination of heightened tariff costs and persistently elevated interest rates is anticipated to encourage a deceleration in business investment and hiring throughout the latter part of 2025 and into 2026.
Consequently, the unemployment rate is projected to climb to 4.6% in 2026.
Elevated trade barriers affecting US imports and exports are expected to impede international trade, with real imports projected to fall by 7.1% in 2026 and real exports by 1.8%.
Overall, real GDP growth is forecasted at 1.4% in 2025 and 1.5% in 2026, before experiencing acceleration in 2027 and 2028, ultimately stabilizing at a steady-state growth rate of approximately 1.8% by 2029.
In contrast, the upside scenario foresees a significant reduction in average tariffs, potentially dropping to around 7.5% by the end of 2025.
This is contingent upon the successful finalization of trade agreements.
Rapid compliance with the USMCA from Canada and Mexico is expected to drive down effective tariff rates even ahead of a scheduled update in 2026.
Additionally, it is projected that the average tariff on imports from China would decrease to about 30%, while tariffs on the European Union would fall to just 5%.
Despite these favorable conditions, substantial economic growth is still anticipated at a diminished rate compared to prior years, primarily because consumer spending has grown more quickly than income, suggesting a slowdown may be needed.
Lower tariffs are expected to facilitate a quicker reduction in inflation, thereby enhancing consumer purchasing power.
As inflation recedes, the Fed can adopt a more accommodating monetary policy stance, including quarter-per-quarter rate cuts of 25 basis points starting in the third quarter of 2025 and extending through the fourth quarter of 2026.
The forthcoming budget bill is also projected to extend current tax provisions while contributing lesser amounts to the federal deficit than previously forecasted, avoiding tax hikes and helping stabilize the bond market.
In this environment of improved trade relations and decreased tariffs, business investment is predicted to rebound given that earlier uncertainty had stifled growth.
The compounding effects of lower interest rates and inflation would further incentivize investment growth, bolstered by deregulation and advancements in artificial intelligence that will likely enhance productivity over the forecast timeframe.
On the other hand, the downside scenario envisions a more significant escalation in tariffs, forecasted to rise to about 25%.
Trade negotiations are anticipated to stall, leading to higher tariffs on imports from key partners, including a staggering 75% on China and 25% on Canada, Mexico, and the European Union.
The net effect is that most other countries would encounter a 10% tariff.
Policy changes set to unfold could lead the bond market to react adversely, with the yield on the 10-year treasury predicted to ascend above 5% by the end of 2025.
This generates additional fiscal constraints resulting in austerity measures consisting of spending cuts and higher taxes to stabilize the bonds market.
In consequence of escalating tariffs and stringent fiscal policies, the United States risks entering a recession by the fourth quarter of 2025, with a projected grim timeline for recovery, not regaining its pre-recession GDP levels until early 2027.
Declines are anticipated across all economic sectors in 2026, predicting a real GDP contraction of 1.7%, with declines in consumer spending, government spending, business investment, imports, and exports all occurring year-over-year.
A substantial economic impact can be expected, as federal spending runs weak, dragging growth rates down further in 2026 and 2027, while hesitancy from policymakers to introduce stronger measures persists until 2028 and 2029.
With the dual impacts of rising inflation and the unemployment rate, the Federal Reserve faces a critical choice between maintaining its inflation versus full employment goals.
Consequently, it holds interest rates steady until the fourth quarter of 2025, at which point a cautious initial cut of just 50 basis points occurs as inflation continues to rise.
As conditions worsen in bond markets, and with signs of inflation stabilizing, the Fed is prompted to make more aggressive cuts, reducing rates by 100 basis points in the first quarter of 2026, followed by further reductions of 50 basis points in each subsequent quarter.
Only in 2027 does the Fed anticipate a gradual return to raising rates toward more neutral levels.
The complex landscape for consumer spending illustrates a slowdown, with real personal consumption expenditures (PCE) showing a modest increase of 1.2% at annual rates in the first quarter of 2025, contrasting sharply with the strong 4% growth recorded in the fourth quarter of 2024.
Spending on durable goods has seen the most substantial deceleration, plummeting by 3.8% in the first quarter of 2025 after a robust increase of over 12% in the previous quarter.
Despite anticipated tariff increases, consumer spending did not surge in anticipation of heightened costs; rather, it reflected a general pullback attributed to waning consumer sentiment.
The University of Michigan’s consumer sentiment index fell by 18.2% from December 2024 to June 2025, while year-ahead inflation expectations rose from 3.3% in January to 5.1% by June.
Nevertheless, the Conference Board’s consumer confidence index rebounded in May 2025, increasing by over 12 points to register at 98.0, a level slightly improved compared to June 2024.
In the near term, consumer spending is projected to remain subdued, as aggregate wages are registering slower year-over-year growth when compared to aggregate spending since July 2024.
Even with anticipated Fed interest rate cuts in the fourth quarter of 2025, elevated long-term rates will likely impede the flow of monetary policy.
In addition, higher delinquency rates on credit cards and auto loans indicate certain consumer segments may grapple with accessing debt to boost spending.
Looking ahead, real consumer spending is anticipated to rise 1.4% in 2025, marginally increasing to 1.5% in 2026.
Further exacerbating matters, durable goods spending is expected to decline by 0.7% in 2025 and decrease by 0.2% in 2026.
Although nondurable goods expenditure is expected to grow by 1.4% in 2025 and 0.7% in 2026, spending on services is projected to climb by 1.5% in both years as services remain less sensitive to tariff implications and elevated interest rates.
Business investment continues to be a pivotal indicator of the economy’s long-term viability as it fosters the productive capacity essential for growth.
Currently, investment is hindered by weak business confidence, which has deteriorated in light of uncertainty.
The National Federation of Independent Business’ small business optimism index has seen a continual decline since December 2024, with only slight improvements noted in May 2025.
Plans for capital expenditures have plunged to their lowest levels since 2020, as reflected in survey data from regional Federal Reserve Banks indicating diminished outlooks for business conditions.
Interest rates play a critical role in shaping investment behavior.
Corporate borrowing rates have surged alongside inflation, yet there has been a slight reduction since 2023, though rates remain elevated relative to pre-pandemic standards.
Fortunately, many firms hold excess cash compared to pre-pandemic levels, allowing businesses to circumvent borrowing at inflated rates.
After experiencing a 1.5% downturn in the first quarter of 2025, structure investments are forecasted to continue to retreat into early 2026.
Overall, structure investment is expected to drop 1.6% in 2025 and 0.9% in 2026, notwithstanding a projected rebound in structure investment during the second quarter of 2026.
In addition to structures, businesses are also investing in machinery and equipment (M&E), along with intellectual property (IP) such as software and artificial intelligence.
In a bid to sidestep tariffs, firms stepped up M&E purchases in the first quarter of 2025, with real spending surging 24.7% (at annual rates) compared to the prior quarter.
However, overall growth is expected to diminish as tariff costs take their toll.
Investment in M&E is expected to experience minimal growth at just 0.1% in 2025, before declining by 2.5% in 2026.
Conversely, intellectual property investment is projected to remain strong, showing increases of 2.4% in 2025 and 3.7% in 2026.
The anticipated resumption of bonus depreciation, phased out under the TCJA, is set to bolster investment spending beginning in the following year, although short-term growth remains inhibited by higher tariffs and interest rates, expecting an overall rise of merely 0.7% for business investment in 2025, down from 3.7% recorded in 2024.
As interest rates are predicted to decrease and uncertainty diminishes, business investment is expected to recover at a rate of 1.1% in 2026, with a significant acceleration upwards of 4.6% anticipated in 2027.
Foreign trade remains clouded by uncertainties due to fluctuating tariff regulations.
Recent court rulings have challenged President Donald Trump’s authority to impose tariffs under the International Emergency Economic Powers Act (IEEPA).
On May 28, the Court of International Trade invalidated nationwide tariffs and a separate court restricted tariffs on two plaintiffs.
Currently, these rulings are under appeal, but they do not affect tariffs imposed under different legal authorities.
In the baseline scenario, it is predicted that the average tariff rate on goods imported into the US will rise by 12 percentage points, translating into a new level of approximately 14.5%.
Factors contributing to this rise include the expectation of a 50% tariff on imports from China, a 20% rate on the European Union, a 3% tariff on goods from Mexico and Canada, and a general 10% tariff on other nations.
It is important to note that import tariffs on Canada and Mexico are expected to decline gradually as more goods achieve compliance with the USMCA.
In the downside scenario, the average tariff rate could see a drastic 22-percentage-point increase, exemplifying a potential case where tariffs could rise to 75% on goods from China, 25% on both the European Union and North American partners, and 10% on others.
The imposition of these tariffs is likely to result in complicated adjustments for businesses, driving decisions regarding supply chains and inventories based on shifting relative prices.
As elevated tariffs persist, imports and exports are still expected to demonstrate the most significant fluctuations.
Real export growth in 2025 may rise by just 0.4%, while real imports are projected to increase by 2.9%, primarily driven by an influx of goods as importers rushed to beat potential tariff applications earlier in the year.
However, expectations for trade growth become subdued by the close of 2025.
In 2026, exports are anticipated to decline by 1.8%, and imports are projected to suffer a steep drop of 7.1%.
The anticipated export decline may be surprising given tariff impositions, yet several factors explain this dichotomy.
About half of imports currently serve as intermediate goods for US businesses, complicating immediate substitution for locally produced items.
As US producers face higher costs from imported goods, they may struggle to invest or may be forced to pass these costs on to consumers, thereby reducing competitive pricing on exports.
The tariff strategy may inadvertently shield US manufacturers from import competition, thus hindering their ability to make globally competitive products.
Ultimately, the prospect of realizing benefits from tariffs is a long-term endeavor, requiring substantial investment in manufacturing facilities and workforce training, likely exceeding the forecasts’ timeline.
In the interim, the immediate burden of tariffs will likely weigh heavily on American households and businesses, presenting hurdles in the transition period as industries regather and adjust.
image source from：deloitte
