March 5, 2025 • 26 mins
Instead of the “Trump bump” we were talking about at the beginning of the year, a combination of mass terminations across the federal government (many of which may be illegal), sweeping tariffs and a whole lot of uncertainty could be leading to a Trump slump. Or is it, as Treasury Secretary Scott Bessent reassured us this week, just a period of transition?
That’s the question we tackle on this episode of Trumponomics. Host Stephanie Flanders speaks with Evercore ISI’s Kathryn Holston, who served as a White House senior economist last year and before that in the office of the chief economist of the World Bank, and Anna Wong, chief US economist for Bloomberg Economics.
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Episode Transcript
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Speaker 1 (00:02):
Bloomberg Audio Studios, podcasts, radio news. Tariffs are about making
America rich again and making America great again. And it's happening,
and it will happen rather quickly. There'll be a little disturbance,
but we're okay with that.
Speaker 2 (00:29):
Welcome to Trumponomics, the podcast that looks at the economic
world of Donald Trump, how he's already shaped the global economy,
and what on earth is going to happen next. Today
we're asking have Donald Trump and Elon Musk stalled the
US economy? A week or two ago, the highly influential
now cast of the US economy that updates every day
(00:52):
was suggesting that the US economy was going to grow
at an annual rate of two point three percent in
the first three months of this year. But now a
lieu of negative data just in the past week has
that measure predicting the economy will shrink by nearly three percent. Now,
that's the first time that gauge has turned negative since
twenty twenty two. Now it's just one measure, it's a
(01:14):
now cast, It jumps around, But several prominent Wall Street
forecasters are also now expecting the US economy to shrink
just in those first three months of the year, and investors,
amid all the gloom, amid all the worry about tariffs
and other things, are betting on three interest rate cuts
by the US Central Bank, the FED to support the
(01:35):
economy this year, rather more than they were expecting a
while back. So is this all Donald Trump an Elon
Musk's fault instead of that Trump bump to the economy
that we were talking about at the beginning of the year.
Has a combination of layoffs in the federal government, sweeping tariffs,
and a whole lot of uncertainty raised the prospect of
a Trump slump or is it as the Treasury sectary
(01:57):
Scott bessn't reassured us this week, just a period of transition. Well,
to answer that, we felt here at Trumponomics that we
had to double down on the number of economists on
the show. So we have two pH d economists, both
of whom spent time one time or another in the
President's Council of Economic Advisors in the recent past. First
(02:23):
our guest Catherine Holston, new to the show now at
Evercore ASI Research, was a senior economist in the White
House last year and before that in the Office of
the chief Economists of the World Bank. Catherine, very good
of you to be here.
Speaker 1 (02:37):
Thank you so much for having me. It's great to
be here.
Speaker 2 (02:39):
And our regular in house guest, Anna Wong, chief US
economists for Bloomberg Economics and also formerly an economist at
the Federal Reserve and at the Council of Economic Advisors
in the White House swamps comment during Donald Trump's first
time Anna, always good to have you.
Speaker 3 (02:54):
Oh, it's good to be here again.
Speaker 2 (02:55):
Look, there's two pieces of this, and I told you
before we started recording a little bit about having so
many super smart economists, though very happy that we're all women,
to talk about the impact of tariffs, of the so
called Department of Government efficiency, and just generally this mood
of gloom that seems to have been starting to descend
(03:17):
around the US economy in the last week or so
after so much optimism about in the first weeks after
President Trump was reelected. We're going to get into all that,
but maybe we could just have a top line view
of how you both think these two shocks, the tariff
shocks and what's happening to the federal government will affect
the economy. Catherine, I know that you are my old
(03:39):
friend and your colleague Krishna Guha have looked at both
trade policy uncertainty and the impact of Elon Musk's DOGE
efforts and how they affect growth this year.
Speaker 1 (03:50):
So I'll start on the tariff side, and I'll mention
that I'm going to be comparing apples and oranges a
little bit in our estimates here, So I just want
to flag that. But this tariff scenario with twenty five
percent on Canada and Mexico going to twenty percent on
China matches the kind of max tariff scenario that we
laid out in a recent note. We think this could
(04:11):
add fifty basis points to core PCEE inflation in twenty
twenty five, another twenty basis points in twenty twenty six.
That's pretty substantially more than our base case in terms
of what the FED is looking at. That includes two
pieces in this shock here. One is the actual impact
of the tariffs, and then second the really big uncertainty
that we're seeing trade policy uncertainty, and there's good reason
(04:34):
to think that's going to continue to remain quite high,
potentially pushing up inflation expectations, which is what the FED
is of course worried about on the DOGE side of things.
Within the government, we think the impact in March, April
and May could lead to payroll employment growth that is
seventy thousand less than expected in a baseline, which is
(04:55):
a pretty big hit considering where we're at with payroll
growth right now.
Speaker 2 (04:59):
We'll get into how that compares with the overall size
of the economy. But Anna, I mean just the same
question to you, your sort of top line thoughts on
this sort of double whammy that we have now coming
you know, at very similar time hitting the US economy
on the tariffs and the DOGE cuts.
Speaker 3 (05:17):
Right, So my top line effect estimates on the direct tariff,
not including the uncertainty, or at least what I think
the FED will have is quite similar to Catherine's estimate.
So I have one point three percent hit on GDP
and also zero point eight percent increase on core PCE.
(05:39):
And these are the estimates implied from the general qualiber
model that the International Finance Division at the FED use
as a dashboard to track coming trade policy in the
first Trump administration, and typically the horizon is about two
years or two or three years. That's because that's usually
our forecast horizon. So if you take that point eight
(06:00):
percent core PCE inflation hit spread over to R three years,
with the maximum arriving in the first two years, that's
very close to where Catherine has on the uncertainty piece.
Though the experience of the First Trade War has taught
I think the FED economist that the general equilibrim model
the estimate might be a maximum take, because ultimately in
(06:23):
the First Trade War, both a GDP estimate and the
core PC estimate actually undershot what the model suggests. The
bigger piece is actually uncertainty, and the FED has developed
a trade policy uncertainty. Currently, the index of that trade
policy uncertainty developed by my former colleagues at a monthly
level is eleven standard deviation above historical norms, and it's
(06:48):
almost doubled the size of the first Trump administration trade
policy uncertainty. So that piece should be translating to a
hit GDP. Hit based on that value should be aboutero
point eight percent GDP and on DOGE, So I think
that the DOGE cuts so far or very small relative
(07:09):
to GDP, so really it doesn't really work in terms
of translating to GDP. However, keep in mind that it
is the difference in the fiscal impulse that affects GDP growth. Right,
So if the first two quarters of the DOCHE cuts
has generated a bigger change a decline in fiscal spending
compared to last year, which is the quarter still under Biden,
(07:33):
then that rate of change annualized could generate a pretty
large decline in GDP growth. And according to the shock
model that Bloomberg Economics has developed, the contour of the
GDP growth from DOCHE excitivities should begin to show up
in the first and second quarter of this year, and
especially peaking in terms of GDP growth in the fourth quarter. However,
(07:57):
the impact on payrolls, as Catherine suggested, will be more
obvious sooner, and the February payrolls, which we will be
receiving this Friday, we expect we won't be seeing much
of that yet. However you'll start to see that in
the next month. And also just again the uncertainty alone
you talked about the domain gloom economic data we have received.
Speaker 2 (08:20):
What is a.
Speaker 3 (08:21):
Sign of weakness is the pullback in consumption which we
saw in January. Last December it was very strong, but
then in January the consumers pulled back, so there's no
underlying strength and consumptions just pulling back. And as we
see more of this pullback as a retrenchment to the
strength last fall, you're going to see more and more
(08:43):
impetus on this pressure on GDP growth.
Speaker 2 (08:46):
ANA in the sort of educational byways department, just to
get our sense around this trade policy uncertainty, and you
talk about it being eleven standard deviations from so when
you sit roughly meaning when we say that.
Speaker 3 (09:01):
In terms of the index, this index goes back to
the nineteen sixties and the Fed Economist collected mentions of
the trade policy uncertainty or references of trade policy uncertainty
in media and social media and all the newspapers, and
right now the index has doubled the level of twenty sixteen,
(09:23):
which means that uncertainty is through the roof and there's
just no historical comparisons. Is nineteen sixty at the level
of uncertainty we're facing right now.
Speaker 2 (09:34):
And I guess we have been saying that the tariffs
that were announced this week are taking US tariffs back
to where they were in the forties. Obviously we're still
not at the levels of that preceded that era, there
were much higher tariffs than the global economy before that,
and I guess that's one thing that the President says
is we're in some sense going back to some previous
(09:54):
eras for that, Anna was mentioning the fed's Trade policy
Uncertainty measure, which has become something as a sort of
standard thing that people refer to. But I noted in
your recent research with Krishna, you're also thinking about DOGE
policy uncertainty and starting to think that that might be
(10:14):
almost of the same order of magnitude. So could you
just talk us through it, because obviously I suspect you
agree that the narrow impact of those federal layoffs is
not necessarily going to move the dial that much. But
it's this sort of broader ripple effect that's.
Speaker 1 (10:30):
Right, and we think it plays out, you know, maybe
quite similarly to how adding trade policy uncertainty to our
general equilibrium models does. Because the thing that's unique about
trade policy uncertainty right now is that it's much larger
in level terms, as Anna said, but it's also has
the potential to be very long lasting. And this is
really not what you would model if you were seeking
(10:52):
efficiency in the model, and so we wanted to think
about how the same impact might be coming out of DOGE,
and specifically how the uncertainty for private sector firms that
are heavily exposed to federal contracts and grants might weigh
on decisions to hire or potentially even do layoffs at
(11:15):
these firms. So there's three pieces that we look at here.
The first, as you mentioned, is the direct impact of
firing probationary employees and other employees in the federal government,
and that's relatively small given the number of workers that
we have in the US. There are two point four
million federal civilian employees. We don't know how many federal
(11:36):
contractors there are, but some estimates from Brookings suggest there
are more than five million, more than a two to
one ratio between federal contractors and federal employees, and another
two point four million employees potentially connected to grants. So
what we do is we look at first our baseline
for direct impacts on federal payrolls. This year, I think
(12:00):
there could be two hundred thousand federal workers fired over
the year. That includes the seventy five thousand who have
taken the deferred resignation scheme. But we also look at
two impacts on private sector payrolls. The first is really
just the direct impact for if there are substantial cuts
to federal contracts and grants. So we're not seeing that
(12:22):
yet on a large scale, but if that plays out,
we think it's reasonable to assume that firms are not
going to be able to hold onto all of their
employees as these contracts and grants are cut. The piece
that we're calling DOGE policy uncertainty or DPU, and here
I would just say TPU trade policy uncertainty. This is
(12:44):
something that's measured that we have an index going back
really far. DPU we're putting forward as a proof of
concept for just another form of uncertainty that's really unknown
how this will operate. And so this is not meant
to be precise estimates, but just to say, if we
make what we think are pretty modest reasonable assumptions, can
(13:04):
we see this having big impacts in the private sector.
And the answer that we get is yes. So we
first construct what we call employment at risk in the
private sector, and so this is just if at the
industry level, industries are receiving federal contracts, just look at
that relative to the share of output in those industries
(13:26):
and then look at how many employees we think might
be supported by these contracts. And then once we have that,
we can say, maybe, let's assume five percent of these
employees at risk are not maintained in payroll growth because
of this DOGE policy uncertainty. We want to think about
two kind of distinct scenarios around the uncertainty. The first
(13:49):
is uncertainty lasts for maybe three months. We can think
of this as a case where if you're a federal
contractor maybe you can maintain your current employees, you institute
a hiring freeze, leading payroll growth to be lower than
last year. And in this scenario, we might have uncertainty
(14:09):
resolving when DOGE kind of finishes whatever it's choosing to
do in a few months, and we might see some
catchup hiring over the rest of the year as these
firms go back and bring on workers. So in this case,
we see some larger impacts in March, April, and May,
but we then because of this catchup hiring in our baseline,
only see about fifty thousand fewer payroll over the year
(14:32):
coming out of this effect, which is really not very large.
But then we look at another scenario where we still
have a relatively low magnitude of uncertainty, but it drags
out over the remainder of twenty twenty five, and in
that case, we can get something like three hundred and
thirty thousand fewer payrolls over the year just from this
DPU effect, just by assuming that maybe initially firms are
(14:56):
hiring less, but then over time they're actually having to
go through with layof and the continued weight of this
uncertainty induces kind of a paralysis effect on these firms
that are pretty heavily exposed to federal contracts in grants.
Speaker 2 (15:10):
It's interesting, just while we're recording this, which is on
a Tuesday afternoon, the S and P five hundred has
lost all the gains that it made since Donald Trump
was elected in November. We've had something like three point
four trillion dollars increase in the S and P five
hundred index that we'd had in the weeks after Donald
Trump's election win, and that has now all been completely
(15:33):
wiped out in a big chunk of it from this
the negativity around the tariff news. So neither of you
are market analysts, and I wouldn't ask you to comment
on that but is this overdone? How likely is it
that we will actually have a recession or a serious
bout of stagflation as a result of this, These policies
(15:53):
that have been it's fair to say, you know, unexpectedly
aggressive in the first few weeks of the Trump ad ministry.
Speaker 3 (16:01):
Stackflation requires the word stack. Typically in a recession, with
contraction of economic activities, you also have a decline in inflation.
So for inflation to be rising, meaning that firms continuing
to be successful, not just trying, but successful at passing
(16:23):
through higher prices. For stackflation to happen, we will need
to see this. And that's not my baseline because I
still agree with Powell that inflation expectations are anchored and
from what we're seeing, firms actually have very little pricing
power left to pass through these price increase And second
of all, the second piece of these is that I
(16:44):
think that there's just structural component to tariffs and a
negotiation component to the tariffs, and the tariffs on Canada
and Mexico are the negotiation pillar of tariffs, and those
will go away. My baseline is that they'll come and
go really quickly. The ones on China was the ones
(17:05):
I have in my baseline, in my earlier baseline last year,
I have the tariffs on Chinese goods going to forty
five percent. We're very close to that. Now those will stick,
and I think that is the piece that to me,
is the biggest source of permanent inflationary risk, particularly because
a larger portion of the goods we import from China
(17:27):
are consumption goods as opposed to our trade with Canada
and Mexico, which are primarily intermediate goods.
Speaker 2 (17:37):
And let just quickly come back on you, I mean,
careful listeners to this show will maybe note that though
you may well think there's an emphasis on negotiation in
the Canada and Mexico tariffs, we have all been and
you have been surprised so far by how willing and
aggressive Donald Trump has been to put these tariffs on.
We had a delay, but now against expectations, he's gone
(17:59):
ahead with full rate of twenty five percent. Many people
thought it would be graduated. It's fair to say you've
been a bit surprised.
Speaker 3 (18:07):
Yeah, I was a bit surprised. Then I went back
to look at his playbook in twenty eighteen and twenty nineteen.
Then I realized there was a long period of the
FED in the first half of twenty nineteen where all
we worried about actually is not the Chinese tariffs, but
on auto tariffs and on tariffs on Canada and Mexico.
(18:30):
And recall that Trump was very close to using AIBA
on Mexico. Mexico was the country that was able to
push the line on using emergency power. This time he
actually used it. So what that period of tariffs spears
on Canada and Mexico shows is that it turns out
that those two countries are always on Trump's list to hit,
(18:54):
even back then.
Speaker 2 (18:55):
Catherine, I think there's a few forecasses that are now
suggesting that no one is suggesting really that there will
be a recession. I mean, are we overdoing this or
is there actually in all this uncertainty a possible sort
of trigger point where we could be kind of find
ourselves in recession.
Speaker 1 (19:12):
I don't think it's overdoing it that there's a trigger
point out there. I share a kind of Anna's base
case that the twenty five percent tariffs on Canada and
Mexico likely will not hold for very long, but that's
because they're just too economically damaging if they do. And
of course, if we end up in that scenario, it
changes the call. I think now I'm not seeing stagflation,
(19:34):
but if that seems like it's going to maintain, it
does change things.
Speaker 2 (19:38):
So if we just carry on with the policies that
we now have implemented by the administration, the twenty five
percent tariffs against our two most important trading partners and
the ones that are forecast to come in I mean
actually have been declared to come in, that that would
potentially be ass cause of a recession where just everyone's
vetting on that they won't stick.
Speaker 1 (19:58):
I don't think it's automatic res but I think the
risk really is there, and particularly there's so much trade
between these three countries, there's supply chain impacts that are
going to be really damaging. We've just seen the effects
of big supply chain disruptions. Of course, this is a
different way would play out than during the pandemic, but
(20:18):
we know that that can be quite inflationary, and I
would just stress that the economic fundamentals going into this
administration were quite good. So this is really kind of
a test case of how much policy uncertainty and actual
policies now with the tariffs, can we throw at things.
And to Anna's point about inflation expectations, the FED is
(20:39):
really trying to assess two things. They're trying to assess,
is weakening growth that we're now seeing in the data
going to feed into unemployment? And they're trying to assess
is the inflation risk going to show up in inflation expectations.
These are really the two triggers for movement one way
or the other. But the FED, the markets, the three
(21:01):
of us are all facing the same uncertainty in actually
seeing that underlying data. And so what's really difficult right
now is the TPU. The trade uncertainty is likely to
remain quite high. We think that this doge uncertainty could
be kind of clouding what's going on with underlying payrolls
and really giving us some actual negative effects on unemployment.
(21:25):
And this just makes it very hard for the FED
to assess do the underlying fundamentals warrant a rate cut
or even a rate increase in the face of inflation
expectations really becoming unanchored. The other thing that I would
just stress is very different from twenty eighteen to nineteen
is the initial conditions of this economy and the idea
(21:46):
that the FED might have a little bit of a
lower threshold for allowing inflation expectations to go up at all.
Here I'm talking about longer term inflation expectations, but I
think if those start to move up, it's going to
be very hard that have Fed to say, actually, this
is just one time tariffs and we'll look through it,
because there are so many other shocks in the economy
(22:07):
that it's just really hard to make that determination.
Speaker 2 (22:10):
I guess I had had a final question for Anna,
which is sort of slightly stepping back. I mean, having
been through Brexit in the UK and from a lot
of these trade things, there's a hit to the economy
that's not a fatal, but a sort of measurable hit
that you didn't need to have if you hadn't reduced
your openness to your major trading partners, something that the
(22:31):
UK has done with Brexit. And the implication of that,
it seemed to me, was that you're sort of in
a hole, and then you have to find positives that
are going to offset that hole. You shut yourself in
the foot, or at least you know, stubbed your toe
pretty badly, and you have to find some way to
make it up. It feels like we're in that kind
of situation. We've decided, for whatever reason, to do this
damage to our trading situation, and that's going to have
(22:54):
a certain hit, not necessarily a fatal hit, but a
certain hit the recovery and to growth and maybe to
other things. But do you think and are the kind
of policies that investors were focused on at the beginning
of the administration that made them positive about growth and investment,
you know, the tax cuts being made permanent, the deregulation agenda,
(23:19):
potentially a smaller, leaner government. Do you think all those
things are still much bigger, potentially positives than the negatives
that we're going to see from this uncertainty and this
trade hit. Or do you think, actually we're not talking
about very different magnitudes here, and it's a little bit
touch and go whether this administration is going to be
really good for the economy overall.
Speaker 3 (23:41):
That's a really good question. My read of the economic
framework of the administration, or at least the beliefs of
the top economic policy advisor, how they see the economy,
how they interpret the world, is that they truly think
the size of the government is too big, and they
are focused on getting rid of this crowding out effect
(24:05):
which they see as generating more regulations which is inflationary,
and also reduce productive capacity and economy. So everything they're
doing right now with the DOCHE cuts is to shrink
the size of the government. At the same time, the
policy package include raising tariffs because they need to. What
(24:28):
they want to do is to raise the taxes on
the foreign and international sector while lower the barriers and
taxes in the domestic economy. So it's like a full package.
You can't see each pillar in isolation. Right, it looks
like a lot of the contour of the economic impact
of DOCHE and tariffs from all our model are concentrated
(24:52):
in the first two years. The trade policy uncertainty, it
actually goes away really quickly. If Trump suddenly to wait,
I'm making a deal, and then the next day you
see that policy uncertainty plunging faster than the actual tariff level. Right,
the tariff level will takes time to go down, but
it actually is the decline in trade policy that would
(25:14):
suddenly spur this reversal of growth. So I think, based
on all the models I've assessed that whatever the positive
benefits of this DOGE and deregulation agenda, and also the
pernicious effect of tariffs will start to fade away in
the second half of Trump's administration, while whatever benefits to
(25:35):
the fiscal agenda will start to kick in the second half.
So basically JD. Van's election as the twenty twenty eighth
president is really a bet that this contour of the
benefits of their economic agenda will start to kick in
in the second half, while it would be pained in
the first two years.
Speaker 2 (25:54):
Well, and of course today will be when they start
dating the Trump vance recovery and they'll forget about anything
that happened to the stock market before. I think that's excellent, Anna.
It is indeed a period of transition and a transition
to who knows what, but I think we'll be charting
it in in Trumpanomics. It has been a very trump
andomic episode. But thank you very much to Anna and
(26:17):
to Catherine. I'm sure we'll have you both back. But
that's that's it for now. Thank you, thanks for listening
to Trump and Nomics from Bloomberg. It was hosted by
me Stephanie Flanders, and I was joined by Anna Wong
and Catherine Holston. Trump and Nomics is produced by Summer,
Sadi and Moses and with help from Chris Martlu and
(26:39):
sound design by Blake Maples. Brendan Francis Newnham is our
executive producer and to help others find the show, please
rate and review it highly wherever you listen to podcasts
Bloomberg Audio Studios, podcasts, radio news. Tariffs are about making
America rich again and making America great again. And it's happening,
and it will happen rather quickly. There'll be a little disturbance,
but we're okay with that.
Speaker 2 (00:29):
Welcome to Trumponomics, the podcast that looks at the economic
world of Donald Trump, how he's already shaped the global economy,
and what on earth is going to happen next. Today
we're asking have Donald Trump and Elon Musk stalled the
US economy? A week or two ago, the highly influential
now cast of the US economy that updates every day
(00:52):
was suggesting that the US economy was going to grow
at an annual rate of two point three percent in
the first three months of this year. But now a
lieu of negative data just in the past week has
that measure predicting the economy will shrink by nearly three percent. Now,
that's the first time that gauge has turned negative since
twenty twenty two. Now it's just one measure, it's a
(01:14):
now cast, It jumps around, But several prominent Wall Street
forecasters are also now expecting the US economy to shrink
just in those first three months of the year, and investors,
amid all the gloom, amid all the worry about tariffs
and other things, are betting on three interest rate cuts
by the US Central Bank, the FED to support the
(01:35):
economy this year, rather more than they were expecting a
while back. So is this all Donald Trump an Elon
Musk's fault instead of that Trump bump to the economy
that we were talking about at the beginning of the year.
Has a combination of layoffs in the federal government, sweeping tariffs,
and a whole lot of uncertainty raised the prospect of
a Trump slump or is it as the Treasury sectary
(01:57):
Scott bessn't reassured us this week, just a period of transition. Well,
to answer that, we felt here at Trumponomics that we
had to double down on the number of economists on
the show. So we have two pH d economists, both
of whom spent time one time or another in the
President's Council of Economic Advisors in the recent past. First
(02:23):
our guest Catherine Holston, new to the show now at
Evercore ASI Research, was a senior economist in the White
House last year and before that in the Office of
the chief Economists of the World Bank. Catherine, very good
of you to be here.
Speaker 1 (02:37):
Thank you so much for having me. It's great to
be here.
Speaker 2 (02:39):
And our regular in house guest, Anna Wong, chief US
economists for Bloomberg Economics and also formerly an economist at
the Federal Reserve and at the Council of Economic Advisors
in the White House swamps comment during Donald Trump's first
time Anna, always good to have you.
Speaker 3 (02:54):
Oh, it's good to be here again.
Speaker 2 (02:55):
Look, there's two pieces of this, and I told you
before we started recording a little bit about having so
many super smart economists, though very happy that we're all women,
to talk about the impact of tariffs, of the so
called Department of Government efficiency, and just generally this mood
of gloom that seems to have been starting to descend
(03:17):
around the US economy in the last week or so
after so much optimism about in the first weeks after
President Trump was reelected. We're going to get into all that,
but maybe we could just have a top line view
of how you both think these two shocks, the tariff
shocks and what's happening to the federal government will affect
the economy. Catherine, I know that you are my old
(03:39):
friend and your colleague Krishna Guha have looked at both
trade policy uncertainty and the impact of Elon Musk's DOGE
efforts and how they affect growth this year.
Speaker 1 (03:50):
So I'll start on the tariff side, and I'll mention
that I'm going to be comparing apples and oranges a
little bit in our estimates here, So I just want
to flag that. But this tariff scenario with twenty five
percent on Canada and Mexico going to twenty percent on
China matches the kind of max tariff scenario that we
laid out in a recent note. We think this could
(04:11):
add fifty basis points to core PCEE inflation in twenty
twenty five, another twenty basis points in twenty twenty six.
That's pretty substantially more than our base case in terms
of what the FED is looking at. That includes two
pieces in this shock here. One is the actual impact
of the tariffs, and then second the really big uncertainty
that we're seeing trade policy uncertainty, and there's good reason
(04:34):
to think that's going to continue to remain quite high,
potentially pushing up inflation expectations, which is what the FED
is of course worried about on the DOGE side of things.
Within the government, we think the impact in March, April
and May could lead to payroll employment growth that is
seventy thousand less than expected in a baseline, which is
(04:55):
a pretty big hit considering where we're at with payroll
growth right now.
Speaker 2 (04:59):
We'll get into how that compares with the overall size
of the economy. But Anna, I mean just the same
question to you, your sort of top line thoughts on
this sort of double whammy that we have now coming
you know, at very similar time hitting the US economy
on the tariffs and the DOGE cuts.
Speaker 3 (05:17):
Right, So my top line effect estimates on the direct tariff,
not including the uncertainty, or at least what I think
the FED will have is quite similar to Catherine's estimate.
So I have one point three percent hit on GDP
and also zero point eight percent increase on core PCE.
(05:39):
And these are the estimates implied from the general qualiber
model that the International Finance Division at the FED use
as a dashboard to track coming trade policy in the
first Trump administration, and typically the horizon is about two
years or two or three years. That's because that's usually
our forecast horizon. So if you take that point eight
(06:00):
percent core PCE inflation hit spread over to R three years,
with the maximum arriving in the first two years, that's
very close to where Catherine has on the uncertainty piece.
Though the experience of the First Trade War has taught
I think the FED economist that the general equilibrim model
the estimate might be a maximum take, because ultimately in
(06:23):
the First Trade War, both a GDP estimate and the
core PC estimate actually undershot what the model suggests. The
bigger piece is actually uncertainty, and the FED has developed
a trade policy uncertainty. Currently, the index of that trade
policy uncertainty developed by my former colleagues at a monthly
level is eleven standard deviation above historical norms, and it's
(06:48):
almost doubled the size of the first Trump administration trade
policy uncertainty. So that piece should be translating to a
hit GDP. Hit based on that value should be aboutero
point eight percent GDP and on DOGE, So I think
that the DOGE cuts so far or very small relative
(07:09):
to GDP, so really it doesn't really work in terms
of translating to GDP. However, keep in mind that it
is the difference in the fiscal impulse that affects GDP growth. Right,
So if the first two quarters of the DOCHE cuts
has generated a bigger change a decline in fiscal spending
compared to last year, which is the quarter still under Biden,
(07:33):
then that rate of change annualized could generate a pretty
large decline in GDP growth. And according to the shock
model that Bloomberg Economics has developed, the contour of the
GDP growth from DOCHE excitivities should begin to show up
in the first and second quarter of this year, and
especially peaking in terms of GDP growth in the fourth quarter. However,
(07:57):
the impact on payrolls, as Catherine suggested, will be more
obvious sooner, and the February payrolls, which we will be
receiving this Friday, we expect we won't be seeing much
of that yet. However you'll start to see that in
the next month. And also just again the uncertainty alone
you talked about the domain gloom economic data we have received.
Speaker 2 (08:20):
What is a.
Speaker 3 (08:21):
Sign of weakness is the pullback in consumption which we
saw in January. Last December it was very strong, but
then in January the consumers pulled back, so there's no
underlying strength and consumptions just pulling back. And as we
see more of this pullback as a retrenchment to the
strength last fall, you're going to see more and more
(08:43):
impetus on this pressure on GDP growth.
Speaker 2 (08:46):
ANA in the sort of educational byways department, just to
get our sense around this trade policy uncertainty, and you
talk about it being eleven standard deviations from so when
you sit roughly meaning when we say that.
Speaker 3 (09:01):
In terms of the index, this index goes back to
the nineteen sixties and the Fed Economist collected mentions of
the trade policy uncertainty or references of trade policy uncertainty
in media and social media and all the newspapers, and
right now the index has doubled the level of twenty sixteen,
(09:23):
which means that uncertainty is through the roof and there's
just no historical comparisons. Is nineteen sixty at the level
of uncertainty we're facing right now.
Speaker 2 (09:34):
And I guess we have been saying that the tariffs
that were announced this week are taking US tariffs back
to where they were in the forties. Obviously we're still
not at the levels of that preceded that era, there
were much higher tariffs than the global economy before that,
and I guess that's one thing that the President says
is we're in some sense going back to some previous
(09:54):
eras for that, Anna was mentioning the fed's Trade policy
Uncertainty measure, which has become something as a sort of
standard thing that people refer to. But I noted in
your recent research with Krishna, you're also thinking about DOGE
policy uncertainty and starting to think that that might be
(10:14):
almost of the same order of magnitude. So could you
just talk us through it, because obviously I suspect you
agree that the narrow impact of those federal layoffs is
not necessarily going to move the dial that much. But
it's this sort of broader ripple effect that's.
Speaker 1 (10:30):
Right, and we think it plays out, you know, maybe
quite similarly to how adding trade policy uncertainty to our
general equilibrium models does. Because the thing that's unique about
trade policy uncertainty right now is that it's much larger
in level terms, as Anna said, but it's also has
the potential to be very long lasting. And this is
really not what you would model if you were seeking
(10:52):
efficiency in the model, and so we wanted to think
about how the same impact might be coming out of DOGE,
and specifically how the uncertainty for private sector firms that
are heavily exposed to federal contracts and grants might weigh
on decisions to hire or potentially even do layoffs at
(11:15):
these firms. So there's three pieces that we look at here.
The first, as you mentioned, is the direct impact of
firing probationary employees and other employees in the federal government,
and that's relatively small given the number of workers that
we have in the US. There are two point four
million federal civilian employees. We don't know how many federal
(11:36):
contractors there are, but some estimates from Brookings suggest there
are more than five million, more than a two to
one ratio between federal contractors and federal employees, and another
two point four million employees potentially connected to grants. So
what we do is we look at first our baseline
for direct impacts on federal payrolls. This year, I think
(12:00):
there could be two hundred thousand federal workers fired over
the year. That includes the seventy five thousand who have
taken the deferred resignation scheme. But we also look at
two impacts on private sector payrolls. The first is really
just the direct impact for if there are substantial cuts
to federal contracts and grants. So we're not seeing that
(12:22):
yet on a large scale, but if that plays out,
we think it's reasonable to assume that firms are not
going to be able to hold onto all of their
employees as these contracts and grants are cut. The piece
that we're calling DOGE policy uncertainty or DPU, and here
I would just say TPU trade policy uncertainty. This is
(12:44):
something that's measured that we have an index going back
really far. DPU we're putting forward as a proof of
concept for just another form of uncertainty that's really unknown
how this will operate. And so this is not meant
to be precise estimates, but just to say, if we
make what we think are pretty modest reasonable assumptions, can
(13:04):
we see this having big impacts in the private sector.
And the answer that we get is yes. So we
first construct what we call employment at risk in the
private sector, and so this is just if at the
industry level, industries are receiving federal contracts, just look at
that relative to the share of output in those industries
(13:26):
and then look at how many employees we think might
be supported by these contracts. And then once we have that,
we can say, maybe, let's assume five percent of these
employees at risk are not maintained in payroll growth because
of this DOGE policy uncertainty. We want to think about
two kind of distinct scenarios around the uncertainty. The first
(13:49):
is uncertainty lasts for maybe three months. We can think
of this as a case where if you're a federal
contractor maybe you can maintain your current employees, you institute
a hiring freeze, leading payroll growth to be lower than
last year. And in this scenario, we might have uncertainty
(14:09):
resolving when DOGE kind of finishes whatever it's choosing to
do in a few months, and we might see some
catchup hiring over the rest of the year as these
firms go back and bring on workers. So in this case,
we see some larger impacts in March, April, and May,
but we then because of this catchup hiring in our baseline,
only see about fifty thousand fewer payroll over the year
(14:32):
coming out of this effect, which is really not very large.
But then we look at another scenario where we still
have a relatively low magnitude of uncertainty, but it drags
out over the remainder of twenty twenty five, and in
that case, we can get something like three hundred and
thirty thousand fewer payrolls over the year just from this
DPU effect, just by assuming that maybe initially firms are
(14:56):
hiring less, but then over time they're actually having to
go through with layof and the continued weight of this
uncertainty induces kind of a paralysis effect on these firms
that are pretty heavily exposed to federal contracts in grants.
Speaker 2 (15:10):
It's interesting, just while we're recording this, which is on
a Tuesday afternoon, the S and P five hundred has
lost all the gains that it made since Donald Trump
was elected in November. We've had something like three point
four trillion dollars increase in the S and P five
hundred index that we'd had in the weeks after Donald
Trump's election win, and that has now all been completely
(15:33):
wiped out in a big chunk of it from this
the negativity around the tariff news. So neither of you
are market analysts, and I wouldn't ask you to comment
on that but is this overdone? How likely is it
that we will actually have a recession or a serious
bout of stagflation as a result of this, These policies
(15:53):
that have been it's fair to say, you know, unexpectedly
aggressive in the first few weeks of the Trump ad ministry.
Speaker 3 (16:01):
Stackflation requires the word stack. Typically in a recession, with
contraction of economic activities, you also have a decline in inflation.
So for inflation to be rising, meaning that firms continuing
to be successful, not just trying, but successful at passing
(16:23):
through higher prices. For stackflation to happen, we will need
to see this. And that's not my baseline because I
still agree with Powell that inflation expectations are anchored and
from what we're seeing, firms actually have very little pricing
power left to pass through these price increase And second
of all, the second piece of these is that I
(16:44):
think that there's just structural component to tariffs and a
negotiation component to the tariffs, and the tariffs on Canada
and Mexico are the negotiation pillar of tariffs, and those
will go away. My baseline is that they'll come and
go really quickly. The ones on China was the ones
(17:05):
I have in my baseline, in my earlier baseline last year,
I have the tariffs on Chinese goods going to forty
five percent. We're very close to that. Now those will stick,
and I think that is the piece that to me,
is the biggest source of permanent inflationary risk, particularly because
a larger portion of the goods we import from China
(17:27):
are consumption goods as opposed to our trade with Canada
and Mexico, which are primarily intermediate goods.
Speaker 2 (17:37):
And let just quickly come back on you, I mean,
careful listeners to this show will maybe note that though
you may well think there's an emphasis on negotiation in
the Canada and Mexico tariffs, we have all been and
you have been surprised so far by how willing and
aggressive Donald Trump has been to put these tariffs on.
We had a delay, but now against expectations, he's gone
(17:59):
ahead with full rate of twenty five percent. Many people
thought it would be graduated. It's fair to say you've
been a bit surprised.
Speaker 3 (18:07):
Yeah, I was a bit surprised. Then I went back
to look at his playbook in twenty eighteen and twenty nineteen.
Then I realized there was a long period of the
FED in the first half of twenty nineteen where all
we worried about actually is not the Chinese tariffs, but
on auto tariffs and on tariffs on Canada and Mexico.
(18:30):
And recall that Trump was very close to using AIBA
on Mexico. Mexico was the country that was able to
push the line on using emergency power. This time he
actually used it. So what that period of tariffs spears
on Canada and Mexico shows is that it turns out
that those two countries are always on Trump's list to hit,
(18:54):
even back then.
Speaker 2 (18:55):
Catherine, I think there's a few forecasses that are now
suggesting that no one is suggesting really that there will
be a recession. I mean, are we overdoing this or
is there actually in all this uncertainty a possible sort
of trigger point where we could be kind of find
ourselves in recession.
Speaker 1 (19:12):
I don't think it's overdoing it that there's a trigger
point out there. I share a kind of Anna's base
case that the twenty five percent tariffs on Canada and
Mexico likely will not hold for very long, but that's
because they're just too economically damaging if they do. And
of course, if we end up in that scenario, it
changes the call. I think now I'm not seeing stagflation,
(19:34):
but if that seems like it's going to maintain, it
does change things.
Speaker 2 (19:38):
So if we just carry on with the policies that
we now have implemented by the administration, the twenty five
percent tariffs against our two most important trading partners and
the ones that are forecast to come in I mean
actually have been declared to come in, that that would
potentially be ass cause of a recession where just everyone's
vetting on that they won't stick.
Speaker 1 (19:58):
I don't think it's automatic res but I think the
risk really is there, and particularly there's so much trade
between these three countries, there's supply chain impacts that are
going to be really damaging. We've just seen the effects
of big supply chain disruptions. Of course, this is a
different way would play out than during the pandemic, but
(20:18):
we know that that can be quite inflationary, and I
would just stress that the economic fundamentals going into this
administration were quite good. So this is really kind of
a test case of how much policy uncertainty and actual
policies now with the tariffs, can we throw at things.
And to Anna's point about inflation expectations, the FED is
(20:39):
really trying to assess two things. They're trying to assess,
is weakening growth that we're now seeing in the data
going to feed into unemployment? And they're trying to assess
is the inflation risk going to show up in inflation expectations.
These are really the two triggers for movement one way
or the other. But the FED, the markets, the three
(21:01):
of us are all facing the same uncertainty in actually
seeing that underlying data. And so what's really difficult right
now is the TPU. The trade uncertainty is likely to
remain quite high. We think that this doge uncertainty could
be kind of clouding what's going on with underlying payrolls
and really giving us some actual negative effects on unemployment.
(21:25):
And this just makes it very hard for the FED
to assess do the underlying fundamentals warrant a rate cut
or even a rate increase in the face of inflation
expectations really becoming unanchored. The other thing that I would
just stress is very different from twenty eighteen to nineteen
is the initial conditions of this economy and the idea
(21:46):
that the FED might have a little bit of a
lower threshold for allowing inflation expectations to go up at all.
Here I'm talking about longer term inflation expectations, but I
think if those start to move up, it's going to
be very hard that have Fed to say, actually, this
is just one time tariffs and we'll look through it,
because there are so many other shocks in the economy
(22:07):
that it's just really hard to make that determination.
Speaker 2 (22:10):
I guess I had had a final question for Anna,
which is sort of slightly stepping back. I mean, having
been through Brexit in the UK and from a lot
of these trade things, there's a hit to the economy
that's not a fatal, but a sort of measurable hit
that you didn't need to have if you hadn't reduced
your openness to your major trading partners, something that the
(22:31):
UK has done with Brexit. And the implication of that,
it seemed to me, was that you're sort of in
a hole, and then you have to find positives that
are going to offset that hole. You shut yourself in
the foot, or at least you know, stubbed your toe
pretty badly, and you have to find some way to
make it up. It feels like we're in that kind
of situation. We've decided, for whatever reason, to do this
damage to our trading situation, and that's going to have
(22:54):
a certain hit, not necessarily a fatal hit, but a
certain hit the recovery and to growth and maybe to
other things. But do you think and are the kind
of policies that investors were focused on at the beginning
of the administration that made them positive about growth and investment,
you know, the tax cuts being made permanent, the deregulation agenda,
(23:19):
potentially a smaller, leaner government. Do you think all those
things are still much bigger, potentially positives than the negatives
that we're going to see from this uncertainty and this
trade hit. Or do you think, actually we're not talking
about very different magnitudes here, and it's a little bit
touch and go whether this administration is going to be
really good for the economy overall.
Speaker 3 (23:41):
That's a really good question. My read of the economic
framework of the administration, or at least the beliefs of
the top economic policy advisor, how they see the economy,
how they interpret the world, is that they truly think
the size of the government is too big, and they
are focused on getting rid of this crowding out effect
(24:05):
which they see as generating more regulations which is inflationary,
and also reduce productive capacity and economy. So everything they're
doing right now with the DOCHE cuts is to shrink
the size of the government. At the same time, the
policy package include raising tariffs because they need to. What
(24:28):
they want to do is to raise the taxes on
the foreign and international sector while lower the barriers and
taxes in the domestic economy. So it's like a full package.
You can't see each pillar in isolation. Right, it looks
like a lot of the contour of the economic impact
of DOCHE and tariffs from all our model are concentrated
(24:52):
in the first two years. The trade policy uncertainty, it
actually goes away really quickly. If Trump suddenly to wait,
I'm making a deal, and then the next day you
see that policy uncertainty plunging faster than the actual tariff level. Right,
the tariff level will takes time to go down, but
it actually is the decline in trade policy that would
(25:14):
suddenly spur this reversal of growth. So I think, based
on all the models I've assessed that whatever the positive
benefits of this DOGE and deregulation agenda, and also the
pernicious effect of tariffs will start to fade away in
the second half of Trump's administration, while whatever benefits to
(25:35):
the fiscal agenda will start to kick in the second half.
So basically JD. Van's election as the twenty twenty eighth
president is really a bet that this contour of the
benefits of their economic agenda will start to kick in
in the second half, while it would be pained in
the first two years.
Speaker 2 (25:54):
Well, and of course today will be when they start
dating the Trump vance recovery and they'll forget about anything
that happened to the stock market before. I think that's excellent, Anna.
It is indeed a period of transition and a transition
to who knows what, but I think we'll be charting
it in in Trumpanomics. It has been a very trump
andomic episode. But thank you very much to Anna and
(26:17):
to Catherine. I'm sure we'll have you both back. But
that's that's it for now. Thank you, thanks for listening
to Trump and Nomics from Bloomberg. It was hosted by
me Stephanie Flanders, and I was joined by Anna Wong
and Catherine Holston. Trump and Nomics is produced by Summer,
Sadi and Moses and with help from Chris Martlu and
(26:39):
sound design by Blake Maples. Brendan Francis Newnham is our
executive producer and to help others find the show, please
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