The U.S. economy was on relatively solid footing heading into 2025, but a growing trade war and aggressive government layoffs have shaken up the economic outlook.
The Federal Open Market Committee’s (FOMC) latest long-term economic projections from December 2024 still suggest a soft landing for the U.S. economy that includes slowing gross domestic product growth but no recession. However, the Donald Trump administration and its Department of Government Efficiency (DOGE) have implemented bold and controversial policy measures, making the next several months a critical period for the economy. Labor market conditions have remained resilient so far, but a growing number of economists are anticipating negative U.S. GDP growth in the first quarter. The Federal Reserve has also paused its interest rate cuts and is facing a difficult balancing act in 2025.
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Economic recessions are no reason for panic and have been a regular occurrence over the past century. However, investors can make the most of a difficult situation by knowing which risk factors to watch and how to position their portfolios to optimize their performance if a recession hits in 2025. Here’s what to consider:
— 2025 recession risk factors.
— Will there be a recession in 2025?
— What to invest in during a recession.
2025 Recession Risk Factors
Many factors can trigger or contribute to a recession, but three specific issues are likely the biggest risks to economic stability in 2025.
The primary economic risk factor in 2025 is tariffs. In the first few months of his second term, President Trump has already implemented and threatened to implement aggressive tariffs on goods imported from China and other U.S. trade partners, making tariffs a central part of his economic plan.
As of March 17, Trump has implemented new 20% tariffs on all Chinese imports and 25% tariffs on imports from Canada and Mexico, along with 25% tariffs on all steel and aluminum imports. Not surprisingly, U.S. trade partners have retaliated by issuing their own tariffs on U.S. exports. Trump has been extremely fluid in his trade war policies, implementing, delaying and threatening new tariffs on a weekly basis as other nations react.
Supporters of Trump’s tariff strategy say it will help U.S. businesses compete with lower-cost international businesses and encourage American companies to hire U.S. workers and choose to manufacture goods domestically. However, critics of the tariff strategy argue tariffs will force U.S. companies to pay higher prices for imported goods and components, and many of these companies will simply pass on those higher costs to consumers by raising prices. Widespread price hikes could be a nightmare scenario for an economy that is already dealing with elevated inflation.
Any investor who hasn’t been living under a rock for the past two years is already aware that inflation is another economic risk factor in 2025.
The Federal Reserve has made significant progress in bringing down inflation, but the latest core personal consumption expenditures (PCE) price index reading in late February suggests inflation remains elevated. Core PCE, which excludes volatile food and energy prices and is the Fed’s preferred inflation measure, was up 2.6% year over year in January, above the FOMC’s 2% target.
In its latest long-term economic projections in December, the FOMC called for only two 25-basis point rate cuts in 2025, bringing the fed funds target range down to between 3.75% and 4% entering 2026. However, the bond market is pricing in a greater than 50% chance that the FOMC will cut rates at least three times by the end of 2025, as of mid-March.
A third economic risk factor is the Trump administration’s DOGE, led by Tesla Inc. (ticker: TSLA) CEO Elon Musk. DOGE has already cut an estimated 222,000 government jobs in an effort to reduce wasteful spending. In addition, DOGE has cut more than 2,300 government contracts. DOGE estimates it has saved American taxpayers $115 billion, but those savings may come at a cost and have been overstated on numerous items, according to an analysis by NPR. Government layoffs will contribute to U.S. unemployment, reduce consumer spending and weigh on GDP growth. In addition, private companies that have lost government contracts could respond with their own layoffs, compounding the problem.
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Will There Be a Recession in 2025?
Fortunately, inflation and tariffs have not yet dragged down the U.S. economy, but investors should continue to monitor the labor market and other economic data in the coming months.
The U.S. economy added 151,000 jobs in February, and the U.S. unemployment rate remained at 4.1%. A 4.1% unemployment rate is not historically high, but it is well above 2023 lows of 3.4%. U.S. GDP growth dropped from 3.1% in the third quarter of 2024 to 2.3% in the fourth quarter. The latest Federal Reserve economic projections suggest that growth will slow to an annual rate of 2.1% in 2025.
U.S. household debt hit a record $18.04 trillion in February, including a record-high $1.21 trillion in credit card debt, and concerns over Trump’s unpredictable policymaking recently sent U.S. consumer sentiment to its lowest level in eight months.
Bill Adams, chief economist for Comerica Bank, says Trump’s tariffs create an upside inflation risk that is difficult to quantify at this point.
“The policy changes day to day and minute to minute, but the high-level takeaway is that tariff rates look likely to be higher in the second half of 2025 than they were in the first. That would increase the cost of imported consumer goods and input costs for service-providing businesses, likely interrupting inflation’s move lower,” Adams says.
Adams isn’t the only one concerned about the Trump administration’s economic impact. The S&P 500 is down 4.8% so far in 2025. The New York Fed’s recession probability model suggests there is a 27% chance of a U.S. recession sometime in the next 12 months. The Atlanta Fed’s GDPNow model is calling for U.S. GDP to decline by 2.8% in the first quarter of 2025.
High valuations in areas of the technology sector have some investors concerned the stock market could be in the early stages of a crash similar to the dot-com bubble.
David Bahnsen, chief investment officer at The Bahnsen Group, says the recent market pullback has barely moved the needle on bloated tech stock valuations.
“While many tech stocks are cheaper than they were a few weeks ago, a 10% stock drop on a company trading at 60x earnings just means they are trading at 55x now. The overall valuation froth, even if all fundamentals and operating conditions deliver best-case results, is the market’s biggest vulnerability,” Bahnsen says.
What to Invest in During a Recession
There are several general strategies investors can use to manage risk and take advantage of opportunities should the U.S. slip into a recession in 2025.
First, consider reducing exposure to volatile stocks and increasing cash holdings. Cash may not be the most exciting play, but it reduces market risk and provides financial flexibility if a recession creates potential buying opportunities in 2025. In addition, investors can still earn more than 4% interest on a one-year certificate of deposit right now, potentially locking in that yield even if the Fed resumes cutting rates.
Certain stocks and market sectors are more defensive than others and tend to outperform the rest of the market during recessions. Utility stocks, health care stocks and consumer staples stocks are considered defensive investments because their earnings tend to be insulated from economic cycles and swings in consumer confidence.
In addition, certain individual stocks have outperformed during each of the past two U.S. recessions. Walmart Inc. (WMT), Netflix Inc. (NFLX) and T-Mobile US Inc. (TMUS) are just three examples of stocks that beat the S&P 500 in both 2008 and 2020.
Investors with longer-term financial goals have another alternative as well — simply ignore a recession and stay the course.
Michael Landsberg, chief investment officer at Landsberg Bennett Private Wealth Management, says investors can take the opportunity to reassess the diversification and balance of their portfolios.
“For most investors, a process to reduce portfolio volatility rewards them with good long-term performance and provides the ability to weather short-term shocks in the market without emotion,” Landsberg says.
For example, he is underweight the high-flying “Magnificent Seven” technology stocks: Microsoft Corp. (MSFT), Amazon Inc. (AMZN), Meta Platforms Inc. (META), Apple Inc. (AAPL), Alphabet Inc. (GOOG, GOOGL), Nvidia Corp. (NVDA) and Tesla.
“We think you will see additional institutional selling pressure on some of these Mag Seven names as the new Russell index composition rules take effect later this month,” Landsberg says.
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Recession 2025: What to Watch and How to Prepare originally appeared on usnews.com
Update 03/17/25: This story was published at an earlier date and has been updated with new information.
