Tariff-ied: The Precarious U.S. Consumer

It’s almost hard to believe how quickly markets have turned in 2025. After U.S. economic and market exceptionalism powered domestic equities to a second consecutive year of returns above 20%, the opening months of 2025 have seen a 10% correction for the S&P 500 and a 14% peak-to-trough decline of the Nasdaq. While it’s tempting to attribute this strictly to President Trump’s aggressive tariff policy, we argue it is also because the market consensus has come around to the realization that the U.S. consumer is in a weaker spot than commonly assumed in late 2024. This has implications for the Federal Reserve (Fed) and the interest rate policy. A strong consumer could handle tariffs, and such policies would likely lead to inflation and the Fed remaining on hold or possibly hiking. But we see a weaker consumer who, in the face of higher prices for imports, would reduce spending in other areas, ultimately leading to a weaker economy and rate cuts from the Fed.

As we argued in our Capital Markets Forecast, Investing in a Chutes & Ladders Economy: Gaming Out Portfolios in 2025, consumers are in decent shape but not strong enough to keep powering the economy at above-trend growth rates like in the past several years. This became clear in the first few months of 2025 in the form of surveys showing concerns about tariffs and spending data that reversed gains from late last year. We have very little confidence in predicting how the trade war will turn out, but our baseline forecast was that tariffs would be used as leverage to negotiate new terms of trade and not remain in place all year. If the delayed tariffs with Canada and Mexico are implemented, along with reciprocal tariffs on imports from Europe, we expect a direct drag on real gross domestic product (GDP) growth of 0.5%–0.75%, with an elevated risk of recession emanating from curtailed capital expenditures (capex) and an associated equity market decline.

Plunging consumer mood

Consumer concerns about tariffs have come through loud and clear. Both major surveys—University of Michigan’s Consumer Sentiment and The Conference Board’s Consumer Confidence—reveal stark concerns that tariffs and a trade war will push inflation higher. The preliminary March reading from the University of Michigan showed one-year-ahead expected inflation jumping to 4.9%, as tariff brinksmanship dominates the news and the market narrative. It had touched a post-pandemic low of 2.6% just five months ago in November 2024 (Figure 1).

That wariness about prices, along with concerns of a slowing labor market, have driven consumer expectations of their financial situations to the lowest since 2022, a year of rampant inflation. The pessimism permeates the survey responses, with more concerns that prices will outpace income, a 12-year low of expectations of a comfortable retirement, and concerns of possible job loss surging to nearly the peak registered during the pandemic. The turn in consumer mood is a key reason that markets have reacted so negatively to the trade war.

Figure 1: Tariff talk is driving up inflation expectations and financial concerns

One-year-ahead expectation inflation (%) and change in personal financial situation (Index=100)

^{Sources: University of Michigan (Sentiment), Wilmington Trust.}

^{Data as of March 14, 2025.}

Reining in spending

It’s not just consumer moods that have shifted to start the year, it’s the actual, “hard data” on spending too. The consumer closed out 2024 with exceptionally strong growth of 4.2% annualized in 4Q 2024, the second strongest in three years. That was enough to generate a market narrative of near-imperviousness—even to tariffs—and even risks of inflation reaccelerating (Figure 2).

We were dubious, as it looked like some of the spending could be chalked up to post-storm replacement spending as well as savvy consumers getting ahead of anticipated tariffs. That thesis gained some traction when January spending data showed a near-complete reversal of the December gains. We still see consumer spending on solid footing, just not so strong that it can keep driving the economy above trend growth as it has since the pandemic and not strong enough to power through a trade war.

Figure 2: Consumer spending got a reality check in January

Real consumer spending on goods and services (month over month, $bn)

^{Sources: Bureau of Economic Analysis, Wilmington Trust.}

^{Data as of December 31, 2024.}

Shorter work week puts the brakes on take home pay

The third important consideration is consumers’ wherewithal, by way of job and wage gains, to keep driving growth and to withstand a trade war. Job growth remains solid and, encouragingly, has reaccelerated over the past few months following a slowdown in mid-2024. Wage growth also remains solid. But these both must be considered alongside the fact that employers have been cutting back on hours. The average workweek for private sector employees in January and February fell to a multi-year low, matching the low point from the pandemic (March 2020), and the lowest since the global financial crisis.

When brought together, job growth and wage growth along with the decline in the number of hours worked reveal a recent slowdown in total wages paid. Ultimately, it’s the total wages paid that determines consumers’ ability to spend, drive the economy, and influence price pressures. The three-month annualized rate fell below 3% in February, a multi-year low, but we acknowledge significant volatility in this metric, and it’s likely to bounce back to the current year-over-year reading of about 4.5% in subsequent months.

Our takeaway is that consumers are still garnering decent gains in take-home pay, but no more than in the years before Covid when inflation was quite docile. Viewed through this lens, consumers have gradually been losing their ability to keep powering the economy forward and are not in great shape right now to withstand the price shocks that tariffs would bring.

Slowdown in total paychecks

Total wages paid (3-month annualized and year-over-year, %)

^{Sources: Bureau of Labor Statistics, Wilmington Trust.}

^{Data as of March 7, 2025.}

Core narrative

The U.S. consumer is in decent shape, but weathering a slowdown in job growth and is not well-positioned to weather the price impacts of a trade war. That precarious state is reflected by spending data that revealed the 4Q 2024 strength was more head-fake than it was true strength which can be seen in consumer surveys where respondents are laying bare the anxiety of trade war impacts. This has become clearer in the past two months and has changed the market narrative. We place a 35% probability of a recession in the next twelve months, and the trade war continues, we expect much slower growth and a higher risk of recession. We maintain neutral weights to all asset classes in portfolios and are prepared to adjust as needed.

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