There has been endless news on the current unprecedented trade war between the US and the rest of the world. The effects on US consumers and the US economy should not be understated, and forecasts incorporating current policy paint a depressing outlook for the US.

In this article, we look at economic forecasts from The Budget Lab at Yale focusing on the effects of tariffs imposed by the US and retaliatory tariffs introduced by US trading partners. We also look at the effects on the US dollar and bond markets.

We have incorporated the current global economic landscape, and what it means for New Zealand, in our April 2025 forecasts.

The Budget Lab at Yale estimates that US consumers will face an average effective tariff rate of a whopping 28%, the highest since 1901 (see Chart 1). Tariffs at the turn of the 20th century were high due to protectionist policies implement by President McKinley during the previous decade, and the absence of income tax as a source of revenue for the US government.

Although the effective 28% rate is unlikely to prevail as businesses and consumers substitute away from goods affected by tariffs, Budget Lab estimates that the average tariff rate will still be 18% after these shifts. This rate would be the highest since 1934, posing a significant burden of around US$2,600 per household in 2025.

Due to current US trade policy, Budget Lab estimates that US real GDP growth will be 1.1 percentage points lower in 2025 than previously expected. In the long-run, trade barriers will result in the US economy remaining 0.6% smaller than would otherwise have been the case.

The IMF also expects slower economic growth, with recently published forecasts showing a downward revision of 0.9 percentage points for 2025, to 1.8%pa. Considering the drop in growth expectations is essentially self-inflicted, the size of this revision is alarming.

The Budget Lab also predicts other adverse effects from US tariffs, with the unemployment rate expected to be 0.57 percentage points higher in the final quarter of 2025, and 770,000 fewer people employed than previously forecast.

This mix of outcomes point towards a dreaded “stagflation” period, where inflation is significantly above trend, but growth slows and is combined with higher unemployment. This combination creates a difficult environment for the US Federal Reserve, as raising interest rates to tame inflation would further slow economic growth and increase unemployment, but cutting interest rates to support growth could exacerbate or prolong the inflation problem.

The likelihood of the US economy heading into a recession in 2025 was low at the start of the year, before the announcements of US import tariffs. However, several banks and rating agencies now see the probability of a recession as being close to 50% (see Chart 2).

Although the base case for most forecasters isn’t a recession, the shift in expectations over the last couple of months represents a stark difference from where the US economy was previously thought to be headed. Inflation had largely been tamed, growth expectations were solid, and the US Federal Reserve appeared to have successfully executed a soft landing for the economy.

The broader US economy also looks set to be affected as foreign investors lose confidence in the US dollar and US-dollar denominated assets.

Confidence in US securities has plummeted, with the S&P500 index down 9.7% from its peak. Normally when there is a sell-off in the stock market, we tend to see a flight of capital to safer assets such as government bonds. However, we have seen the opposite this time around, with US government bonds also suffering a sell off – the 10-year yield rose to 4.4% on April 21 after falling to 4.0% earlier in the month.

The US dollar has fallen against other major currencies, taking the US dollar index to a three-year low, down 10% from the beginning of 2025 (see Chart 3).

This combination of higher bond yields and a weaker dollar suggest international investors are losing confidence in American assets and removing capital from the US. This outcome is important for how the trade war plays out from here, as the bond market appeared to be President Trump’s pain point when he announced the 90-day pause on tariffs on 9 April as bond yields rose, although he later denied his initial comments. President Trump cares about the bond market, because higher bond rates result in higher interest costs on government debt, undermining his goal to lower government costs.

China’s large holdings of US Treasury securities (see Chart 4) also give it a potential lever to retaliate to President Trump’s tariffs. By selling off some of its large holdings, China could significantly hike US bond yields, pushing government borrowing costs higher. However, it is unclear how far China would go down this path, as the sell-off would strengthen the Chinese yuan, potentially hurting export earnings.

President Trump has continued to express his desire for lower interest rates by threatening to push US Federal Reserve Chair Jerome Powell out of his role for not cutting interest rates, despite the Fed’s independence from government (although, like many of his other statements, the President has since backpedalled). President Trump is likely to continue to be disappointed with the Fed, as it is unlikely to move interest rates until more robust data is available, the policy direction is less volatile, and other potentially inflationary policies such as tax cuts and deregulation become clearer.

The current trade war is likely to damage the reputation of the US, have long-lasting effects on how countries approach trade with the US, and influence how investors perceive the risk of US assets. More policy clarity time and are needed throughout the rest of 2025 before we can estimate the long-term damage to the US economy.

Putting long-term damage aside, there are some less negative signs emerging. President Trump has recently altered his stance on China, with US Treasury Secretary Scott Bessent stating “there will be some de-escalation” in the trade war with China in the “very near future”. This statement shows potential for the 145% tariff on Chinese goods imported into the US and 125% on US goods entering China to be reduced, scaling back the negative growth and inflationary effects of trade policy. We will have to see how trade negotiations over the next few months go between the US and its major trading partners. At this stage, though, we need to work on the assumption that economic prospects for the US in 2025 and 2026 remain extremely negative.