Slowing growth, higher prices: A deeper dive into our U.S. forecasts

Our April 2025 forecast update presented a difficult outlook for the United States in 2025: slower growth, higher prices and a rising unemployment rate.

Most of this challenging economic narrative is being driven by quickly shifting trade-related policies from Washington that complicate both the outlook and forecasting process around it.

As a follow to our U.S. forecast update, we answer six key questions we’ve received about the U.S. economy and how we’re thinking about the changes that we’ve made.

1. What approach are you taking towards projections right now?

There is no perfect approach to forecasting right now. Economists are making a number of assumptions in order to generate outlooks, many of which—such as political outcomes—fall outside our traditional scope and credentials. Our focus has been on consistency and transparency of approach and, RBC Economics has leaned on three guiding principles through this process.

First, we utilize what current policy is with only minimal and appropriate conjecture about what comes next. For example, as we outlined in our forecast, we currently assume the average import tariff converges towards 10% as global trade flows adjust relatively quickly to avoid bilateral U.S./China trade. This 10% scenario allows for de-escalation of tariffs on China specifically, and/or for the rest of the world and implies we have already seen peak tariff rates.

Second, we rely heavily on scenario analysis as we did here, which allows us to pivot quickly and demonstrate the breadth of possible outcomes from worst case to best. We continue to advise clients to do the same, laying out plans and process for a wider set of outcomes than usual.

Third, we eschew the idea that in this environment, conviction is an economist’s best attribute. Instead, we rely heavily on transparency of thought to support clients. There are times for rigid point forecasts, and there are times for thoughtful frameworks.

2. You aren’t forecasting a recession. Are you more optimistic about the U.S. economy?

We aren’t forecasting a technical recession in 2025, but we have a significant slowdown in growth which flirts around 0% for three quarters (0.3% in Q2, 0% in Q3, 0.5% in Q4), and could fairly easily tilt the U.S. economy into recession should it experience further downside shocks.

More importantly, we don’t find the word recession helpful. It’s a binary and imprecise term that implies two consecutive quarters of negative growth with some other requirements, but doesn’t capture the magnitude or dynamics of growth in play.

Importantly, the slowdown isn’t just in one pocket of the data. U.S. growth is likely to be driven down by the core pillar of the economy responsible for 70% of growth—a faltering of the steadfast American consumer. About 10% of U.S. consumption is sourced internationally. Even a 10% effective tariff (about half where we are now, but what we expect to hit), will slow real consumer spending by a full percentage point from previous forecast, bringing consumption growth down from 1.6% to 0.6% in 2026.

There are, of course, downside risks to the near-term forecast, particularly as the weight of uncertainty spreads through the economy in ways that are difficult to model or predict, and the wealth effect from volatile financial markets weighs on high-income consumers. There is also the elephant in the room that much (but likely not all) of the weight on the U.S. outlook could be removed from an overnight shift in policy.

And, perhaps more interesting than the recession/no recession call is that we see a larger downgrade to growth in the U.S. than we do for most other developed economies in 2025. In short, our outlook may not contain a technical recession, but it is a serious downgrade.

3. Should we be thinking stagflation with lower growth and higher inflation?

Lower growth and higher inflation are an uncomfortable combination for households and businesses, and can be worse than a recession. Picture job losses combined with rising costs, or slower revenues coupled with rising wage demand.

We’ll concede that the direction of forecasts are stagflationary, but we are a long way from the levels of inflation and growth that marked the 1970s or the pandemic. Moreover, stagflation tends to imply a symmetric concern for lower growth and higher inflation, whereas our unease is currently more around the distribution of risks for inflation. It will be sticky high for the next two years, while growth will be weak, but could rebound in 2026.

So, why are we worried about inflation? For one, our outlook sees the core Consumer Price Index rising to 4.4% by Q4, but then remaining above 2% for all of 2026. Given a more than 20% rise in prices over the past five years, it’s a problematic re-acceleration of inflation in an environment where the ability of the consumer to absorb more cost increases is far more limited than it was in 2018 or 2022.

Second, the risks to our U.S. inflation outlook are tilted to the upside. Tariffs represent a “one-time” level adjustment, but there’s certainly potential for the shock to permeate more broadly into services and wages. It’s a risk the Federal Reserve is likely monitoring closely. It’s also a risk that even if tariffs are removed in the future, firms don’t, in turn, drop prices. Or, that firms take advantage of an inflationary environment to increase prices even on non-tariffed goods—a trend we’ve seen in the past.

Third, inflation is largely a U.S. issue. American tariffs raise prices for American consumers, but they produce mostly disinflationary or deflationary shocks in most countries that aren’t imposing retaliatory tariffs.

4. Why aren’t you forecasting a bigger jump in the unemployment rate with near zero growth for several quarters?

In the short-run, we’ve already witnessed a slight uptick in the unemployment rate thanks to DOGE layoffs, which we expected would drive the unemployment rate up to 4.3%. We’re almost there. Adding tariffs to the mix, we see the unemployment rate hitting 4.8% by year-end. That’s the wrong direction for the labour market.

At the same time, it’s also an unemployment rate we’d typically associate with the best labour markets of the past several decades. In recessions, the unemployment rate would peak anywhere between 6% to 13%. Notably, the rise in the unemployment rate is likely to lag the increase in inflation as firms take some take to scale back production and cut staff in the face of weaker demand.

At play is one of our most important and high conviction U.S. themes: American needs workers, not jobs. The economy is facing a demographic tsunami with the highest amount of retirees ever, the highest share of people over 65, and a working age population that is already near its highest labour force participation rate. Washington’s immigration policies, and labour shortages combined are likely to produce more hiring freezes and reduced hours versus largescale layoffs.

This matters for two core reasons. First, hesitation to reduce workers also puts a floor under how weak the U.S. economy can become as slower growth is less likely to bleed and multiply through the job market and incomes. Second, the shortage of workers is also likely to put a floor under how far wage growth can decelerate as we expect labour power to be maintained at much higher levels than what we have historically seen during slow growth or recessions.

5. What fiscal measures are you assuming in your base case forecast?

Our current base case already incorporates an extension of the Tax Cuts and Jobs Act (TCJA), which is set to be extended at the end of the year. Importantly, since this policy is already in place, its extension would not boost consumption. If TCJA is not extended, we’d have to model in a drop in consumer purchasing power and spending.

If additional tax changes come to fruition—for example, no tax on social security, overtime or TIPS—we would incorporate them, and net, those examples would likely to support the outlook. More broadly and consequential, however, is that the size of U.S. government spending and the market’s concerns about its unsustainability continue to mean that fiscal dominance (over monetary) is still very much at play.

We don’t see the deficit meaningfully shrinking in 2025 despite DOGE-related headlines. At the same time, as the U.S. federal government attempts to slow the growth of government spending (or freeze it), many other major developed economies from Canada to Germany are engaging in sizeable and intentional stimulus. This “fiscal spread” also contributes to our view that the U.S. will struggle more in 2025 than many other developed economies.

6. Does the shifting world order represent an end of U.S. exceptionalism?

There’s a lot of talk about the end of U.S. exceptionalism as U.S. assets sell-off and Washington openly discusses distancing itself from the rest of the world. Some of that concern is fair.

Cyclically, the U.S. looks set to lose its 2025 growth advantage as the economy slows more than other developed economies. Structurally, U.S. policies are clearly designed to produce distance between itself and the rest of the world. Yet, it may be premature to call for the permanent end of U.S. economic outperformance.

The country continues to benefit from strong productivity growth that could, in theory, improve further from tax cuts and deregulation. High-income U.S. consumers also remain very wealthy in terms of income and assets. And, U.S. fiscal spending remains a core support to growth despite talk of DOGE-related cuts. It’s difficult to see the U.S. looking exceptional in 2025, but over the next five years, it continues to remain a major economic engine, regardless of trade and other policies.

Frances Donald is the Chief Economist at RBC and oversees a team of leading professionals, who deliver economic analyses and insights to inform RBC clients around the globe. Frances is a key expert on economic issues and is highly sought after by clients, government leaders, policy makers, and media in the U.S. and Canada.

Carrie Freestone is an economist and a member of the macroeconomic analysis group. She is responsible for examining key economic trends including consumer spending, labour markets, GDP, and inflation.

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