U.S. economy faces heightened uncertainty and risks in third and fourth quarters

After a 0.5% decline in the first quarter, the U.S. economy rebounded and grew 3.8% during Q2, according to the latest estimate from the Bureau of Economic Analysis.¹ But looking ahead, widespread uncertainty about the path forward for interest rates and unpredictable trade policy have somber implications for U.S. economic growth in the remaining months of the year.

Further, a prolonged government shutdown could create widespread problems. None by themselves would exact a big economic cost, but together, the costs quickly add up. For example, government employees won’t receive their paychecks, homebuyers unable to get federal flood insurance may not be able to close on their mortgage, food processors may be unable to get the appropriate certifications from the FDA, and utilities and chemical companies may have difficulty getting the appropriate certifications from the EPA.
 

Inflation is likely picking up steam

Consumer inflation came in hotter than expected in August. The 0.4% increase in the Consumer Price Index (CPI) exceeded the consensus expectation of 0.3% growth and lifted the year-ago rate from 2.7% to 2.9%.² Energy delivered a strong boost, rising 0.7% from July to August. However, the basket of goods highlighted as sensitive to tariffs rose 0.6%, and food inflation accelerated as well. Core CPI, excluding food and energy, rose 0.3%. August’s increase kept the 12-month rate for core CPI at 3.1%, which is not what Fed officials want to see as they contemplate cutting rates in the months ahead.

Following a worrying spike in July, the Producer Price Index (PPI) cooled in August. The PPI for final demand fell 0.1%, well under the expected 0.3% gain.³ The 0.9% increase in July was also revised downward to 0.7%. The latest monthly increase brings the year-ago rate from 3.1% to 2.6%. However, the main driver of August’s decline was energy. The PPI for final demand for energy slid 0.4%. On the other hand, across import-intensive goods, it was another month of price increases, though less than in July. Electronic, computers, and computer equipment prices climbed 1.8% in August. Household furniture prices rose 0.2% after a 0.4% rise in July. The PPI for final demand iron and steel scrap jumped 2.7% after increases of 3.2% in June and 4.5% in July. The PPI has whipsawed in recent months, with wholesalers seeming to absorb higher input costs one month and pass them along to retailers the next.

Signs of softening in the labor market

Around the mid-summer mark, the labor market made a sharp downward swing. July jobs numbers came in below expectations at 73,000 (later revised upward to 79,000).⁴ The July jobs report also included the largest downward revision to previous months’ numbers on record outside of the pandemic. In August, payroll gains for June and July were revised lower by 21,000 jobs. This new data indicates that the U.S. economy lost 13,000 jobs in June, marking the first month of negative employment since December of 2020. The economy then added a paltry 22,000 jobs in August. 

Further, on September 9, the Bureau of Labor Statistics released its preliminary estimate for the benchmark revision to payroll employment.⁵ It showed that employers added 911,000 fewer jobs in the 12 months through March than had been indicated in the monthly payroll figures. This implies that the economy added only about 850,000 jobs during that time — half as many as previously reported.

The unemployment rate was mostly unchanged in August, increasing from 4.2% to 4.3%. The labor participation rate, which had dipped to its lowest reading since late 2022 in July, also held relatively steady at 62.3%. A smaller labor force could be due to large numbers of Baby Boomers retiring, but it may also reflect a more concerning trend: discouraged job seekers exiting the labor market entirely. In addition, the foreign-born labor force is declining sharply, with troubling implications for industries that rely on immigrant labor — in particular farming, food processors, and construction. A shortage of workers in these sectors will increase the burden of high prices for groceries and housing, especially for low-income Americans. With the economy at full employment and little growth in the labor force, either jobs and economic growth will slow, or unemployment will fall, driving up wages and prices.

FOMC cut interest rates despite inflation worries

The rate-setting Federal Open Market Committee took a step toward a more neutral policy stance at September’s meeting. Their quarter-point rate cut was broadly anticipated and marks the first change to the fed funds rate since late 2024. The target range for the fed funds rate is now 4% to 4.25%.

Large, broad-based tariff increases typically increase inflation and could weigh on economic growth. This presents a conundrum to the Fed: when inflation rises, it would normally hold interest rates steady or raise them to cool inflation. Alternatively, during a weakening economy, the Fed would cut rates to encourage economic growth. Given a weakening economy and job growth, the Fed is expected to address the latter first — by cutting rates once or twice more this year by 25 basis points in October and December to bolster job growth.

Unfortunately, in a shutdown, the government stops collecting and publishing key economic statistics. While this may seem the concern of only economists, the Federal Reserve is reliant on these numbers to determine when to cut interest rates. Without them, it is much more likely that monetary authorities could make a mistake.

Uncertainty continues to inhibit growth

Even with lower rates, the uncertain approach to trade policy and its implications for the broader economy could have a cooling effect on economic growth. Heightened uncertainty makes it difficult for companies and consumers to make financial decisions. Businesses might delay investment, and consumers worrying about their job prospects may cut back on spending — both of which slow down the pace of economic growth.

Economic data shows signs that uncertainty is beginning to take a toll on growth. For example, according to the Fed’s July Senior Loan Officer Opinion Survey,⁶ demand for loans is slightly down, which could indicate that businesses anticipate a downturn and are pulling back on capital improvements and inventory. Some banks are also tightening lending standards, especially for credit cards, which may reflect nervousness about consumers’ financial health.

Despite persistent uncertainty and slowing growth, most economists do not predict a recession in 2025. But elevated risks on a variety of fronts could change the outlook quickly. Most apparent is that the trade war could escalate to the point of pushing the economy into recession. Other risks include the possibility of events in Europe, the Middle East, or other oil-producing areas precipitating a spike in energy prices. Consumers or businesses could become so fearful that they stop spending. A downturn in stock prices could also restrain consumer spending, particularly for middle-class consumers, and stunted immigration could generate labor shortages. In the face of heightened uncertainty, these and other risks to the economy remain elevated.