Will the GDP of the USA exceed expectations in 2025? Will inflation and the labor market continue to slow down?

On December 29, Goldman Sachs Chief Economist Jan Hatzius and his team released a report titled 'US Economics Analyst: 10 Questions for 2025', outlining the top ten key themes that will impact the US stock market next year, and providing analysis and answers to the related issues.

Hatzius and others emphasized the robust economic fundamentals at the beginning of the new year, but also warned that the uncertainty of policy changes in the USA and geopolitical risks during Trump's second term may pose pressure on the economic outlook.

1. Will GDP growth exceed the general market expectations?

Yes. Hatzius and others forecast that in 2025, the year-on-year growth rate of the USA's GDP calculated on a Q4/Q4 basis will be 2.4%, slightly lower than Goldman Sachs' previous forecast of 2.5%, but still higher than the general market expectation of 2%. This growth is mainly due to strong consumer spending, robust real income growth, and healthy business investment.

Hatzius also added that although the economic outlook for the USA next year is favorable, there are downside risks, mainly the return of trade tensions, which could provoke foreign tariff retaliation and increase uncertainty, thereby suppressing investment.

In addition, Hatzius and others stated that policy changes from the Trump administration will put pressure on growth in 2025, but will provide a boost in 2026, roughly offsetting the pressure on growth. The economic drag from decreased immigration and increased tariffs may show earlier effects, while the boosting effect of tax cuts requires legislative support, thus taking longer.

Will the growth of consumer spending exceed market expectations?

Yes. Hatzius and others predict that consumer spending growth in the USA will reach 2.3% in 2025, consistent with 2023 and 2024. A key supporting factor is the healthy labor market, which is expected to allow residents' real income to grow at a stable rate of about 2.5%, covering all income levels.

In addition, Hatzius expects the wealth effect to provide additional support for residents' spending—household financial conditions remain strong and have further improved due to the steady rise in stock prices.

Will the labor market continue to slow down?

No. Hatzius and others point out that although the USA labor market has shown slight fatigue this year compared to previous years, it remains strong by historical and international standards, and many are overly concerned about the Sam rule triggered in July—after all, the number of job vacancies in the USA is still high, and there has never been a sign of a layoff spiral (where unemployment leads to reduced consumption, further triggering unemployment).

However, Hatzius also noted that many people subsequently hastily assumed that the labor market problems had been resolved, while in fact, the latest data shows that the state of the USA labor market remains unclear, with the unemployment rate rising back to summer highs, while other Indicators indicate preliminary but not definitive signs of stabilization.

In summary, Goldman Sachs believes that although the unemployment rate needs attention, they still expect the unemployment rate in the USA to decline to 4% in 2025, for three reasons:

1. The number of job vacancies is at a healthy level, and strong growth in final demand should maintain robust growth in labor demand;
2. The main reason for the weakness in the labor market this year is the difficulty in fully absorbing the large number of new immigrants entering the labor market each month in the short term, a trend that has significantly decreased and will further slow down by 2025.
3. Federal Reserve Chairman Powell's remarks at the Jackson Hole meeting and in December.the Federal Open Market CommitteeComments indicate that if the labor market weakens further, the Federal Reserve leadership may push for further interest rate cuts to support employment.

4. Will core Personal Consumption Expenditures (PCE) inflation fall below 2.4% year-on-year after excluding tariff effects?

Yes. Hatzius and others predict that inflation in the USA will continue to decline until it approaches the Federal Reserve's 2% target by the end of 2025, with core PCE inflation excluding tariff effects expected to fall to 2.1%; if tariffs are included, inflation may slightly rise to 2.4%.

Hatzius added that the main drivers of easing inflation are the cooling of wage pressures, the alleviation of lagging inflation, and stability in financial services.

5. Will the Federal Reserve cut interest rates by at least another 50 basis points?

Yes. Goldman Sachs expects the Federal Reserve to cut interest rates in March, June, and September 2025, reducing rates three times at a quarterly or every other meeting frequency.

Although Hatzius and others believe that some Federal Reserve officials seem reluctant to cut rates, and that the risks and actual impacts of tariffs may limit the Fed's room to lower rates next year, Goldman Sachs's baseline and probability-weighted forecasts are more dovish than market pricing for two reasons:

1. Goldman Sachs believes inflation is declining, forecasting a nearly 0.3 percentage point drop in core PCE year-on-year by the next Federal Reserve meeting in March.
2. Goldman Sachs believes that the policy changes during Trump's second term will have a mild impact on inflation, and overall interest rates will continue to decline. Moreover, aggressive policy changes could create bidirectional rate risks. For example, in 2019, after tariffs triggered financial conditions tightening, the Federal Reserve prioritized employment risks over a one-time inflation shock, resulting in a 75 basis point 'insurance cut'.

Will the Federal Reserve's estimate of the neutral interest rate be raised from 3% to at least 3.25%?

Yes. Goldman Sachs has previously pointed out that members of the Federal Reserve FOMC will adjust their estimates of the neutral interest rate upwards over time, as both market pricing and econometric models summarized by Federal Reserve staff indicate levels significantly higher than the current estimates of FOMC members. Since then, the median long-term interest rate estimate among FOMC members has risen from 2.5% to 3%.

Hatzius stated that this estimate may be further increased in 2025, as Goldman Sachs's latest model update shows a neutral rate range of 2.8%-4.6%, with a nominal average of 3.8%, while market pricing is even higher.

Will Trump seek to dismiss or demote Powell?

No. During his first term, Trump repeatedly expressed a desire to fire Powell and find someone who could lower interest rates to take his place, while the FOMC has already indicated that it does not expect any interest rate cuts at the meeting in January next year - if this is the case, it will undoubtedly exacerbate tensions between the White House and the Federal Reserve.

However, Hatzius and others believe that Trump is unlikely to fire or demote Powell for two reasons:

1. Trump's first term has proven that a president cannot arbitrarily fire the chairman of the Federal Reserve, as the law only allows for dismissal for "just cause," and the courts are unlikely to deem "failure to cut rates" as just cause for removal.
2. Powell's term ends in 2026, and the White House may start considering candidates for the Fed chairmanship in the second half of 2025; the waiting time is not long.

8. Will net immigration turn negative?

No. Goldman Sachs stated that after Trump took office, the White House might tighten immigration policy, and Congress may also increase enforcement resources next year, expecting net immigration to decline to 750,000 per year (the pre-pandemic average was about 1 million per year, reaching about 3 million in 2023).

Moreover, this 750,000 mainly consists of legal immigrants, while the deportation of illegal immigrants will roughly offset those seeking asylum and those illegally entering the USA.

9. Will the White House impose universal tariffs?

No. Goldman Sachs believes that imposing a universal tariff of 10%-20% on all imported Commodities in the USA would pose serious risks, and the White House would prefer to avoid potential economic costs and political risks associated with universal tariffs.

Hatzius and others estimate that if an additional 10% universal tariff is added on top of the tariff base in Goldman Sachs' baseline forecast, inflation in the USA will slightly exceed 3% at its peak, the negative impact on GDP growth will peak from an increase of 0.75 percentage points to 1.25 percentage points, and could result in a severe sell-off in the US stock market.

10. Will Congress substantially reduce the primary deficit?

No. Goldman Sachs expects that after Trump is elected president, he will comprehensively continue some of the tax cuts in the 2017 tax reform, restore some expired corporate investment incentives, and implement moderate personal tax cuts, worth about 0.2% of GDP. Goldman Sachs also expects that federal government spending will increase, especially in the defense sector. Therefore, Goldman Sachs predicts that the ratio of the USA's primary deficit to GDP will remain roughly stable over the next year.

Hatzius and others also mentioned that the House Republican leadership recently committed to finding ways to cut $2.5 trillion in mandatory spending programs, and the Trump team indicated that the newly established Department of Government Efficiency could cut at least $2 trillion from the federal budget, but Goldman Sachs believes that these proposals are unlikely to translate into substantial reductions in spending and deficits next year or even by 2026, for two reasons:

1. Republicans in Congress are unlikely to support significant cuts in defense spending, and Trump is also unlikely to support significant cuts in Insurance or Social Security, while cuts in non-defense discretionary spending are also unlikely to yield sufficient savings to significantly alter the trajectory of the primary deficit.
2. These cuts will require support from Democrats regardless, as the annual spending bill is separate from the fiscal policy reforms aimed at reconciliation procedures embraced by the Republican agenda. Although Congressional Republicans might cut other welfare programs, such as Medicaid, these measures may take several years to gradually take effect, and Goldman Sachs expects that the savings will be used to fund new tax cuts rather than reduce the deficit.