US Economy I: The Godot Recession Is Back
During 2022, 2023, and 2024, most economists and investment strategists expected that the dramatic tightening of monetary policy would cause a recession. They observed that the inverting yield curve and the falling Index of Leading Economic Indicators were confirming this outlook. We argued that the recession was the most widely anticipated recession of all times that wasn’t likely to happen. We called it the “Godot recession.” We focused on the reasons for the underlying resilience of the economy and dismissed the widely followed leading indicators of recession as misleading.
The Godot recession may be back in 2025. This time, the cause of the widely anticipated downturn is Trump’s Tariff Turmoil.
According to Polymarket.com, a trading platform, the chance of a recession was relatively low around 20% from the time President Donald Trump was inaugurated on January 20 through March 11. The odds then shot up dramatically, especially after April 2 (“Liberation Day”), reaching 64% on April 8. They fluctuated around 55% after Trump postponed for 90 days the reciprocal tariffs that he had announced on April 2 for all countries with one notable exception: China’s tariff remained 145%. The odds of a recession rose to 66% on May 1 following last week’s batch of weak economic indicators (i.e., consumer confidence, ADP payrolls, M-PMI, and jobless claims). The odds fell to 60% on Friday, May 2, following the release of a stronger-than-expected employment report for April.
While economic growth remains our base-case scenario, we did raise our subjective probability of a “tariff-induced” recession from 20% at the start of the year to 35% on March 5. We wrote, “We are still betting on the resilience of consumers and the economy. However, Trump Turmoil 2.0 is significantly testing the resilience of both. That’s why we’ve recalibrated our subjective probabilities.” On March 31, we raised the odds again to 45% and blamed Trump’s Reign of Tariffs. We wrote, “That 45% is also the probability we see that the stock market’s correction will deepen into a bear market in coming months. Yet we still expect an up year, with the S&P 500 rising above 6000 by year-end.”
In other words, we remained, and remain, believers in the resilience of the economy. It withstood the tightening of monetary policy over the past three years. We expect it will withstand this year’s tariff turmoil.
US Economy II: Lowering Our Odds of a Recession
We are now lowering our odds of recession back down to 35% because we believe that China and the US both may be ready to suspend their tariffs on each other while they negotiate a trade deal. In other words, both sides may be starting to blink. Neither side can bear the pain of a trade war, which might be more painful for China’s economy than America’s economy. On the other hand, Americans have less tolerance for pain than the Chinese (for more on China’s “chiku” ethos, see the Morning Briefing dated April 29, 2025).
We also expect that Trump will declare victory in his trade war with the rest of the world. By the end of the 90-day postponement period of his Liberation Day reciprocal tariffs, the US is likely to have signed numerous agreements with America’s major trading partners. Stragglers might come around during a second 90-day postponement period. Trump needs to put the trade issue behind him to reduce the odds of a recession, which would harm the Republicans’ chances of holding onto their slim majorities in both houses of Congress.
Trump also needs to get this issue resolved quickly now that numerous court cases have been filed challenging his constitutional authority to impose tariffs under his claim that they are warranted by a national crisis that he declared.
We anticipated all the above in our April 7 Morning Briefing titled “Annihilation Days.” We wrote:
“Trump’s Liberation Day last Wednesday triggered Annihilation Days on Thursday and Friday, with the Stock Market Vigilantes giving a costly thumbs-down to Trump’s Reign of Tariffs. Trump officials say they aim to make Main Street wealthy again even if that’s bad for Wall Street. The problem is that Main Street owns lots of equities traded on Wall Street, so the two streets prosper and suffer together. Congress can’t do much to stop Trump given his veto power, but he might get the message that hurting Main Street’s stock portfolios can cause a recession and jeopardize the GOP majority in Congress. If so, he might postpone the reciprocal tariffs, giving trade negotiations time to work. Also, the courts might block Trump’s tariffs. An early end to Trump’s tariff nightmare would result in a V-shaped stock-market bottom. We’re counting on that; the alternative is just plain ugly.”
Sure enough: Trump postponed his reciprocal tariffs two days later, on April 9. The S&P 500 traced out a V-shape, bottoming on April 8 and climbing 14.1% since then through Friday’s close.
We aren’t dismissing the possibility of a recession. There could still be supply disruptions resulting from the still unresolved trade war with China. Regional and national business surveys show weakening economic activity and rising prices during March and April. Measures of consumer confidence are at recessionary levels, especially those that track consumer expectations. The latter is one of the 10 components of the Index of Leading Economic Indicators (LEI), which has been forecasting a recession since late 2022. Meanwhile, the Index of Coincident Economic Indicators (CEI) has been rising to new record highs since then through March!
We are betting on the resilience of consumer spending, which has been boosted by the spending of retiring Baby Boomers. We had been concerned recently about the negative wealth effect on consumption because of the drop in stock prices. Now we are less concerned given the subsequent rebound in stock prices. We are also betting on business spending to remain resilient. While tariff-related uncertainties may weigh on capital spending, we expect that spending related to cloud computing and onshoring will remain strong.
US Economy III: The Most Resilient Labor Market
The CEI probably edged up to another record high during April. That’s because nonfarm payroll employment in private industries, which rose to a record high in April, is one of the four components of the CEI. It tends to boost two of the other components, i.e., real personal income and real manufacturing and trade sales. The fourth CEI component is industrial production, which probably declined in April along with manufacturing aggregate weekly hours, as shown in April’s employment report.
By the way, the S&P 500 is also one of the 10 components of the LEI. We lowered our recession/stagflation odds today partly because the stock market is indicating that the outlook for the economy is improving. Friday’s jobs report also increased our confidence in the resilience of the labor market. Let’s review it:
(1) Earned Income Proxy. Aggregate weekly hours in private industries rose 0.1% m/m to a new record high of 4.7 billion during April. Average hourly earnings rose 0.2% m/m last month. So our Earned Income Proxy for wages and salaries in private industries rose 0.3% to a new record high in April. That augurs well for April’s consumer spending. Indeed, April’s auto sales remained robust at 17.3 million units (saar).
(2) Payroll employment. Payroll employment rose 177,000 during April. We expected 150,000–175,000. So we weren’t surprised, though the consensus expectation was lower at 135,000. The previous two months were revised down by 58,000. Nevertheless, the average for the past three months was a solid increase of 155,000. Much of the strength in payrolls comes from services industries that cater to retiring Baby Boomers, particularly health care and social assistance, leisure and hospitality, and financial activities.
(3) Federal government employment. Employment of federal workers fell only 9,000 last month. That followed a decline of 4,000 in March. So far, the DOGE Boys haven’t had much impact on federal government employment. Solid gains were registered by health care and social assistance (58,200), transportation and warehousing (29,000), and leisure and hospitality (24,000). We acknowledge that the latter two could weaken if the trade war between China and the US persists.
(4) Payroll employment diffusion index. It was encouraging to see that the payroll employment diffusion index remained above 50.0% during April.
Strategy: To Raise or Not To Raise Our S&P 500 Target?
At the start of the year, our S&P 500 target for the end of this year was 7000. When we raised our odds of a recession on March 5 to 35%, we lowered our target to 6400. We lowered it again on March 31 to 6000, when we raised the odds of a recession to 45%.
Now that we are lowering the odds of a recession back to 35%, should we be raising our S&P 500 target back to 6400? We are inclined to do so given the power of the V-shaped rally in the S&P 500. However, we aren’t ready to do so given the following two issues:
(1) Earnings. The outlook for S&P 500 earnings is deteriorating. Tariffs are first and foremost taxes on domestic importers. The 10% baseline tariff on all imports from most countries was announced by Trump on Liberation Day and imposed on April 5. There is also a 25% tariff on autos, aluminum, and steel. The 145% tariff on China remains in force as well.
Over the past 12 months through March, corporate tax receipts totaled $502.19 billion. The currently active tariff rates could raise over $300 billion in import duties over the coming 12 months. That would be a significant increased tax burden on corporate profits unless they are passed through to consumer prices. Some companies, such as those in the auto industry, might find that hard to do.
(2) Valuation. The valuation multiple of the S&P 500 bottomed at 18.1 on April 8. It was back up to 20.5 on Friday. It is very unlikely to bounce back to the 22.1 at which it began the year.