Slow, Steady Growth Should Persist for U.S. Economy
Views You Can Use: President Trump’s pro-growth agenda should overpower the challenges of elevated inflation, tariffs and high interest rates.
Key Takeaways
With interest rates still restrictive and inflation still above target, we expect growth to slow over the near term.
Over time, we expect the pro-business features of President Trump’s agenda to largely support the economy.
We believe diversification across higher-quality and more defensive securities may offer value in today’s evolving backdrop.
The U.S. economy has continued to demonstrate surprising resilience. Despite a lengthy period of elevated inflation and interest rates, the economy expanded 2.8% in 2024, slipping only slightly from 2.9% in 2023.
Quarterly data reveal a slowing pattern. The economy grew at an annualized pace of 2.3% in the fourth quarter of 2024. While still a trend-level growth rate, it was the slowest in three quarters, down from 3.1% in the third quarter and 3% in the second.
We expect this trend to persist as restrictive interest rates and above-target inflation pressure growth. The Federal Reserve (Fed) indicated it’s in no hurry to cut interest rates further, creating another potential near-term headwind. Furthermore, as President Donald Trump’s sweeping policy agenda takes shape, we expect mixed economic effects initially.
We believe this environment continues to underscore the role high-quality equity and fixed-income securities may play in investor portfolios.
How Trump’s Policy Priorities Shape the 2025 Economic Outlook
We expect 2025 to be a year of two halves, underscoring the Fed’s shift to a wait-and-see rate-cut strategy. We expect Trump to rearrange the global order to favor U.S. interests, prolonging the economic divergence between the U.S. and other nations.
We believe the Trump agenda may lead to:
A mixed economy: We expect the economy to slow down in the first half of 2025. New tariffs may weaken consumer demand, while government efficiency initiatives could boost the jobless rate. But, by the year's second half, optimism from deregulation, onshoring and other pro-business initiatives may emerge, fueling positive economic momentum.
A potential inflation resurgence: Despite recent upticks, we still expect inflation to moderate toward the Fed’s 2% target in the first half of 2025. However, new tariffs, immigration policy and increased onshore investments may reignite inflation later in the year. Potential U.S. dollar strength and energy-sector deregulation could ease some inflationary pressures.
Why an Economic Slowdown Remains a Likely Economic Outcome in 2025
We believe the U.S. economy should continue to grow, but the pace may slow amid still-high interest rates and above-target inflation. For these reasons, we put the odds of a slowdown sharply higher than other possible economic scenarios.
Slowdown: We believe growth will slow to a below-trend pace (flat to slightly positive) in the near term before potentially reaccelerating later in the year. We expect the Fed to resume raising rates in mid-2025, which, combined with pro-growth economic policies, could aid the economic backdrop. The odds of a recession are slim, in our view.
Overheated Economy: We believe the chance of growth surprising to the upside has increased recently. In this scenario, we would expect above-trend growth, above-target inflation and tight financial conditions.
Goldilocks: We believe the odds of a Goldilocks economy remain slim and equal those of an overheated economy. The factors comprising this scenario would include inflation dropping to 2% or lower, the Fed continuing to ease and growth persisting at trend or above-trend levels.
What Would a Slowdown Scenario Mean for Investors?
As the economy slows, U.S. Treasury yields will likely fall. We also expect credit spreads to widen. While inflation should moderate, we still expect core inflation (excludes food and energy prices) to remain higher than the Fed’s 2% target in the short term due to:
Continued pressure on the services component of the Consumer Price Index (CPI), mainly from wages and elevated shelter (rent and owner’s equivalent rent), transportation and medical costs.
The ongoing repositioning and rerouting of global supply chains, rising shipping costs and potential tariffs.
Global political tensions and record-high deficits.
Slowdown: Potential Investment Implications
We believe a slowdown is likely.
Fixed Income
In a slowdown, investors should consider:
Shifting to shorter duration. We believe short-duration assets may help manage near-term interest rate volatility. Furthermore, along with generally offering higher yields than cash equivalents, short-duration assets also tend to offer price appreciation potential in a declining rate environment.
Balancing duration exposure. Core bond strategies with intermediate-duration exposure may offer diversification and potential performance advantages as rates broadly decline and equity market volatility rises.
Staying high in credit quality. In addition to delivering diversification to investor portfolios, a modest allocation to high-quality investment-grade credit may now provide more attractive yields. However, we believe credit selection is critical to avoid weaker, economically sensitive issuers.
Maintaining inflation protection. We believe inflation strategies still appear attractive, given that inflation expectations remain higher than average, largely due to tariff policy uncertainty.
Equities and Real Assets
In a slowdown, investors should consider:
Emphasizing quality stocks. Quality companies with higher profitability and healthy balance sheets may offer attractive potential. Investors tend to favor quality companies in more defensive sectors, such as utilities, health care and consumer staples. Additionally, we think select dividend-paying stocks that tend to provide consistent income streams are attractive.
Looking to sustainable growth. Companies with dependable, sustainable earnings growth have tended to outperform competitors with weaker earnings profiles during economic slowdowns. Economically sensitive value sectors, such as financials, industrials and energy, have tended to lag alongside lowered growth expectations.
Treading carefully in the commodities market. As consumer and industrial demand wanes, commodities typically lose their luster. However, we believe gold may continue to shine amid falling interest rates and heightened economic and market uncertainty.
Maintaining selective exposure to real estate stocks. Lower interest rates may boost the attractiveness of real estate investment trusts (REITs) if growth doesn’t slow to recession levels. In such a scenario, we prefer to rely on our REIT managers to identify the best opportunities.
What Would an Overheated Economy Mean for Investors?
If economic growth surprises to the upside, inflation would likely remain above the Fed’s target. A growth surprise scenario could also trigger additional Fed tightening.
Overheated Economy: Potential Investment Implications
We believe there’s a modest chance economic growth will surge.
Fixed Income
If an overheated economy emerges, investors should consider:
Focusing on credit-sensitive assets. Riskier fixed-income securities, including high-yield corporate bonds and bank loans, may offer attractive return potential when the economy is growing.
Maintaining inflation protection. We believe inflation-protection securities, particularly with short durations, are attractive as rates rise and inflation remains elevated.
Avoiding longer-duration assets. With the Fed in tightening mode, longer-duration securities should underperform shorter-duration assets as interest rates rise.
Equities and Real Assets
If an overheated economy emerges, investors should consider:
Focusing on traditional value sectors. The energy and basic materials sectors have typically benefited from higher commodity prices. Utilities have generally provided dependable cash flows and dividends despite higher inflation and interest rates.
Favoring cyclical stocks. Economically sensitive sectors, such as financials, communication services and industrials, have tended to benefit from strong economic activity.
Gauging commodities. Commodities have historically provided attractive returns during periods of economic growth and elevated inflation. However, we believe astute management is required because geopolitics and supply chain issues may heavily influence performance.
Adding exposure to real estate. REITs may outperform their long-term averages as the economy remains robust.
What Would a Goldilocks Scenario Mean for Investors?
If inflation quickly drops to target or below-target levels and the Fed resumes rate cuts, Treasury market volatility may subside. We would expect Treasury yields and mortgage rates to decline, credit spreads to tighten and the economy to expand at trend or above-trend rates.
Goldilocks: Potential Investment Implications
We believe a Goldilocks scenario is slightly more likely than it was in late 2024.
Fixed Income
In a Goldilocks economy, investors should consider:
Evaluating higher-risk bonds. We believe credit-sensitive securities may offer attractive performance potential, particularly high-yield bonds and bank loans, which have historically benefited during economic expansions.
Focusing on nimble duration management. Modest growth, lower inflation and a Fed pivot suggest active duration management may be warranted as markets and rates adjust to the changing backdrop.
Reduce inflation exposure. As inflation subsides, we believe nominal Treasuries may offer better performance potential than Treasury inflation-protected securities (TIPS).
Equities and Real Assets
In a Goldilocks economy, investors should consider:
Looking to growth stocks. Pro-cyclical, growth-oriented sectors have historically outperformed other market sectors in lower-rate, strong-demand environments. This has been particularly evident in the information technology and communication services sectors, where revenues rely on capital expenditures and advertising spending.
Assessing cyclical sectors and small-caps. Economically sensitive holdings, such as banks and consumer discretionary and industrial stocks, have tended to benefit from increased economic activity. Investors typically focus less on fundamentals, such as quality cash flows, in favor of market beta, at least initially. Small-cap stocks could also offer appeal.
Allocating to REITs. We expect REITs to offer solid performance potential as the housing market recovers. Additionally, lower interest rates typically boost the attractiveness of REIT yields.
Limiting exposure to certain commodities. We believe industrial metals and other pro-cyclical commodities may outperform other commodity sectors as economic activity and demand pick up. However, softer inflation correlates with lower prices for energy and food.
What a Slow-Growth Economy May Mean for Portfolio Allocations
We believe maintaining a broadly diversified portfolio may be a prudent strategy in a slow-growth economic backdrop. However, certain investment characteristics deserve consideration in this environment.
For example, given the near-term uncertainty surrounding economic policy priorities, we believe bond investors should consider tactical allocations to interest rate and credit sensitivity. Remaining nimble may be the best approach for credit-sensitive securities, offering opportunities to capture yield advantages across different economic scenarios. And because we expect inflation expectations to remain elevated, inflation-linked strategies may offer value.
Additionally, we believe focusing on quality in equities and real assets will be crucial over the next several months. In our view, companies that can pass along costs to consumers should be able to protect margins from wage and input cost inflation.
More broadly, emphasizing quality may also help investors navigate a slower economy. In general, quality companies — those with healthy balance sheets, higher profitability and more stable cash flows — have tended to offer attractive performance potential as growth slows.
Authors
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The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Investments in fixed income securities are subject to the risks associated with debt securities including credit, price and interest rate risk.
In certain interest rate environments, such as when real interest rates are rising faster than nominal interest rates, inflation-protected securities with similar durations may experience greater losses than other fixed income securities. Interest payments on inflation-protected debt securities will fluctuate as the principal and/or interest is adjusted for inflation and can be unpredictable.
Generally, as interest rates rise, the value of the bonds held in the fund will decline. The opposite is true when interest rates decline.
Diversification does not assure a profit nor does it protect against loss of principal.