Will tariffs trigger a recession?

Episode Summary

Executive Summary: The episode argues that the U.S. is heading toward recession in 2025, driven by a sharp immigration slowdown, historically large tariff increases, weaker consumer real income, rising uncertainty, and a likely downturn in business activity. While Brad questions whether the effects are enough to cause a full recession, Ajay says the combined first- and second-order hits make a recession likely, though policy reversals could quickly improve the outlook.

Main Topics: Recession call for the U.S. in 2025 (Priority: 5/5): Ajay states directly that the U.S. is likely headed for recession this year, despite Brad’s skepticism that growth can simply slow without collapsing. Immigration shock and labor supply slowdown (Priority: 4/5): The conversation links the halt in immigration and enforcement sweeps to reduced labor supply, fewer jobs created, and a modest but meaningful GDP drag. Tariffs, trade war, and inflation pass-through (Priority: 5/5): A major theme is that tariffs have jumped sharply, with partial pass-through to consumers expected to raise prices and cut real spending. Consumer resilience vs. second-order effects (Priority: 4/5): Brad argues the consumer has absorbed past inflation shocks, while Ajay says today’s low savings, weaker confidence, and market losses could force a pullback in spending. Labor market lag and recession timing (Priority: 4/5): Ajay emphasizes that low unemployment and strong recent payrolls are lagging indicators and may not prevent recession if job losses begin. Business confidence and supply-chain disruption (Priority: 5/5): The speakers discuss how extreme tariff levels could halt trade, damage small businesses, and create bankruptcies even if the policy does not last long. Policy offset potential: tax cuts and tariff pauses (Priority: 3/5): Brad points to possible tax cuts and tariff pauses as offsets, while Ajay says they are not yet concrete enough to change the near-term recession view.

Key Arguments: Immigration restrictions reduce labor supply, which lowers job creation and adds an estimated 35 to 50 bps drag on GDP. Tariffs have risen from roughly 2% to about 25% on average, creating a large cost shock to 11% of GDP tied to imports. If 50-60% of tariff costs are passed through, consumer inflation could rise around 4% to 4.5%, squeezing real consumption. Because consumer spending is about 70% of GDP, even a 1.5 percentage-point rise in inflation could subtract roughly 1% from growth in first-order effects. Brad argues the consumer may remain resilient because prior inflation spikes in 2022 did not trigger a major spending collapse. Ajay counters that the current environment lacks the same pent-up demand and excess savings that supported spending in 2022-23. Ajay says consumer confidence has been collapsing, and a higher savings rate could cut spending enough to shave another 1.5% off growth. The labor market is not a reliable near-term safeguard because it typically lags the broader economy. Very high reciprocal tariffs and counter-tariffs could effectively shut down trade, especially harming small and medium-sized businesses. Policy relief could come if tariffs are negotiated down and tax cuts are extended, but these are not yet sufficient to offset the current shock.

Data Points: U.S. growth last year: about 2.5% - Brad references the economy’s pace before the slowdown/recession debate. Immigration-related labor additions: 2 to 2.5 million workers per year - Ajay says this was the annual labor-force boost from 2022 to 2024. GDP drag from immigration changes: 35 to 50 basis points - Ajay’s estimate of the growth impact from the immigration slowdown and enforcement. Average tariff on U.S. imports at start of year: around 2% - Brad contrasts this with the post-April 2 tariff regime. Average tariff on U.S. imports after April 2: around 25% - Ajay and Brad discuss the scale of the tariff shock. China tariff level: 125% or more - Tariffs on China are described as far higher than the rest of the world. U.S. goods imports last year: $3.2 to $3.3 trillion - Ajay uses this to estimate the magnitude of tariff exposure. Imports as share of GDP: about 11% - Used to frame how much of GDP is directly exposed to tariffs. Tariff pass-through to consumers: 50% to 60% - Historical estimate cited for how much tariff costs are borne by consumers. Potential inflation increase from tariffs: roughly 4% to 4.5% - Ajay’s estimate if tariff pass-through occurs and future tariffs do not expand further. Consumer spending share of GDP: 70% - Used to show why real income erosion matters for growth. Growth impact from 1.5pp higher inflation: about 1% - Ajay’s first-order estimate of reduced real consumption. Household wealth increase since COVID: close to $50 trillion - Brad cites wealth gains in homes and equities as support for continued spending. Household savings-rate effect: 2% increase in savings rate - Ajay says this could reduce consumption enough to cut growth by another 1.5%. Current unemployment rate: 4.1% - Brad cites it as evidence the labor market is still strong. Unemployment rate change from last year lows: 70 basis points higher - Ajay notes labor conditions have already worsened from the lows. Expected further unemployment increase: 60 basis points - Ajay’s forecast for additional labor-market deterioration. Recent monthly job creation: 225,000 jobs - Brad uses the latest payroll gain to argue recession is not imminent. Chinese exports to the U.S.: about $400 billion - Ajay says this trade flow could be severely disrupted. U.S. exports to China: about $200 billion - Ajay estimates reciprocal trade exposure.

Pivotal Quotes: "So how do you answer that? In the affirmative, unfortunately." — Ajay Rajadaks: Ajay directly answers the opening recession question. "The jobs market is often a lagging indicator." — Ajay Rajadaks: He explains why a strong current labor market does not rule out a recession. "This time so far, the U.S. dollar has not rallied, even after large tariffs were announced, which is a bit of a problem because it means one large shock absorber is missing." — Ajay Rajadaks: He highlights why tariff pass-through may be more damaging than in past episodes.

Implications: Listeners should expect slower U.S. growth, higher inflation, and rising recession risk if tariffs and immigration restrictions persist. Markets, consumers, and businesses may remain volatile, but policy reversals or negotiated trade deals could quickly improve sentiment.