Trump's series of policy propositions have cast a thick layer of fog over the US economy. Morgan Stanley believes that next year the global market may usher in an America where economic growth is slowing down and inflation is more stubborn.

Morgan Stanley economist Seth B Carpenter's team warned in a recently released forward-looking report that if Trump fulfills his promise to tighten immigration policies and increase tariffs, the US labor market and trade will all be impacted. The next two years will put pressure on US GDP growth, and the downward path of inflation will be even more bumpy.

Considering initial inflationary pressure and the uncertainty of Trump's policies, Damo predicts that the Federal Reserve will remain cautious about the future interest rate path and begin suspending interest rate cuts in the second quarter of next year. However, with economic growth slowing down, employment growth almost stagnated in the second half of 2026. At that time, the Federal Reserve is expected to restart interest rate cuts.

The economy is under heavy pressure

Given that stricter immigration policies and higher tariffs are putting tremendous pressure on the economy, Morgan Stanley expects US GDP growth to slow to 1.9% in 2025 from 2.4% in 2024 and further to 1.3% in 2026.

Damo believes that the new government's expulsion and exclusion of illegal immigrants will cause the number of net immigrants to drop from 3.3 million in 2023 to 0.5 million in 2026. Reduced immigration is expected to keep the labor market tight in 2025, but unemployment will rise in 2026 as economic growth falls below potential levels.

According to Dama estimates, the unemployment rate will be 4.3% by the end of 2024, 4.1% in 2025, and 4.5% in 2026. Fewer immigrants meant a significant drop in employment in 2025 and 2026.

Although the consumer base remains strong, consumption growth is expected to slow significantly in 2025 and 2026 due to factors such as a cooling labor market, rising tariffs, and reduced immigration.

Damo expects actual consumption to grow by 2.6% in 2024, fall to 2.0% in 2025, and 1.3% in 2026. Compared to service consumption, commodity consumption declined less, as lower interest rates supported consumption of durable goods.

In terms of fiscal policy, Morgan Stanley believes that the momentum of fiscal spending in 2025 will weaken. Although the new government will pass tax legislation, it will mainly maintain the current tax reduction policy rather than stimulate economic growth.

Commercial investment will maintain steady growth next year, and AI investment may contribute more to GDP

In the past few years, commercial investment was limited to specific industries, such as the manufacturing investment boom in 2023 and the AI investment wave in 2024.

In particular, AI-related investments have accelerated significantly over the past year, and Damo expects this trend to continue in 2025 and 2026. The increase in AI investment is expected to have a positive impact on investment in data centers, power structures and related technical equipment, directly contributing to GDP growth.

Damo expects actual commercial fixed investment to grow by 4.0% in 2024, 3.9% in 2025, and 3.2% in 2026; structural investment will grow at 1.6% and 5.4% respectively (half of which will be contributed by AI).

AI has begun to drive investment in data warehouses and electricity-related structures. Morgan Stanley anticipates further acceleration in data warehousing and power-related investments.

We expect AI's strong performance to contribute about half of the growth in structured investment in 2025. For 2026, we expect growth to slow to 4%.

Compared to 2025, AI-related structural spending contributed roughly the same in 2026 (3.5 percentage points). However, tariff-related disadvantages reduced growth by three quarters of a percentage point.

Damo predicts that AI investment will increase US GDP by 0.1 percentage points in 2024.

The report points out that in early 2023, investment in data center structures showed an upward trend, and investment in power construction and computers also increased in mid-2023. These three types of commercial investment may indicate the effects of accelerated investment. Additional investment in power-related structures and data centers directly contributed to GDP growth. However, investment in AI-related equipment mainly depends on imports. 75% of domestic computer expenditure is imported, and additional battery storage is almost entirely dependent on imports, so the current positive impact of AI equipment spending on GDP is largely offset by imports.

Investment in AI is expected to have a greater boost to economic growth by 2025, which is expected to increase by 0.25 percentage points. Spending on data warehouses (data warehouses) and power structures will contribute 3.5 percentage points to structural investment and one-tenth of GDP. Although imports are growing faster, spending on computers and related equipment will also make a similar contribution.

By 2026, due to the slowdown in data center construction, the contribution of AI investment to GDP growth may drop to 0.15 percent.

Under high import tariffs, trade is under pressure

Over the next two years, Trump's high import tariff policy is expected to put pressure on imports, while the prospects for slowing Mexican growth and a stronger dollar are expected to slow exports.

Malaysia expects trade to have a slight drag on GDP growth in 2025 (-0.2 percentage points), but the impact will decrease in 2026 (-0.1 percentage points) as import growth slows.

Despite tariffs putting pressure on imports, continued growth in AI investment is expected to support imports, particularly in 2025 and 2026. According to Damo, US companies will continue to look for specialized hardware, advanced electronic equipment and other technical components for AI research, development and infrastructure.

More stubborn inflation

Morgan Stanley expects inflation to continue to slow until the first quarter of 2025, but then become more stubborn.

Specifically, the US core PCE inflation rate will fall to 2.8% in 2024, but due to tight labor markets and high tariff policies, this figure will remain high at 2.5% and 2.4% in 2025 and 2026, which is still higher than the Federal Reserve's target level.

Damo believes that the imposition of tariffs is expected to have a more obvious impact on inflation in late 2025, while the tight labor market may drive wage growth in 2025, putting pressure on service sector inflation.

A more cautious path to cutting interest rates

Trump, who loves monetary easing, comes to power. If careless, it may ignite inflation. The Federal Reserve must be careful and cautious about future interest rate paths.

Morgan Stanley predicts that the Federal Reserve will continue to cut interest rates in the first half of 2025, by 25 basis points each time until the federal funds rate falls to 3.625%. However, due to labor market tension and pressure from service sector inflation, and the impact of remaining seasonal factors, the Federal Reserve may suspend interest rate cuts after May 2025. Meanwhile, the Federal Reserve will end quantitative austerity (QT) in the first quarter of next year.

The Federal Reserve will be able to resume cutting interest rates in the second half of 2026 only after inflation stabilizes and begins to decline, and economic growth slows significantly due to tariffs. Damo expects the federal funds rate to drop to 2.375% by the end of 2026.

Morgan Stanley made assumptions about the outlook for US interest rates in 2025:

Scenario 1: US hard landing — neutral interest rates fall short of expectations and the Federal Reserve is excessively tight. Monetary policy was lagging behind, and it only began to affect the economy in the first quarter of 2025, causing the economy to slow down sharply, and inflation fell below target, forming a hard landing.

Under these circumstances, Damo expects the Federal Reserve to quickly cut interest rates to 1% in the first half of 2025 and maintain it until the second half of 2026. GDP growth is forecast to be -0.3% (quarter-on-quarter) in 2025 and 1.8% in 2026.

Scenario 2: The US accelerates again — the economy rebounds in 2025 due to interest rate cuts. Neutral interest rates were higher than expected, the Federal Reserve cut interest rates too much, the economy accelerated again, and inflation rose as a result.

In this scenario, productivity growth is stronger, and neutral interest rates continue to be high. Damo expects that after the policy interest rate falls to 3.625%, the Federal Reserve will raise interest rates again in the fourth quarter of 2025, raise interest rates to 3.875% at the end of 2025, and further raise interest rates to 4.875% at the end of 2026. GDP growth is forecast to be 2.8% (quarter-on-quarter) in 2025 and 2.3% in 2026.