Markets on edge ahead of Fed rate call as tariffs and rising recession risks threaten to sink US economy

The US economy may be approaching a point of no return and tonight’s FOMC decision and messaging will shape the course of the debate over just how bad it will get over the next 12 months. Sounds pretty serious, doesn’t it? 😱

My opening statement is not meant to be alarmist – there is indeed growing evidence in the economic data that the US economy is on track for a slowdown (how bad is still what the market is trying to determine). Add to this fact, the Fed’s decision tonight will undoubtedly play a role in how things play out. Perhaps more important than the 0.25% rate cut that is already baked in is the Fed’s messaging: How much support will they provide – if any – after tonight’s move? 🤔

Wow, this is just sounding worse and worse! Well, much of the kerfuffle lies with the Trump administration’s fiscal and trade policies. Pitched as “pro-growth” and “pro-jobs”, they are arguably beginning to bear the wrong kinds of fruit. Some of these policies are bleeding into the Fed’s domain, putting it between the rock of stubbornly high inflation and the hard place of a weakening labour market.

For investors, the message is clear: Risks are mounting and the outlook demands close attention. With the fate of the world’s economy to be decided within the next 24 hours (da-da-daaaammmm 🚨), let’s investigate what’s at stake. Just how bad are things really for the US economy, and should you be worried about your portfolio?

Growth slows, drivers falter

An interesting research report from major investment bank UBS lobbed onto my desk yesterday. Titled “US Economic Outlook 2025-2027: What next?”, it outlines the bank’s views on, well, as the title suggests, what’s coming next for the US economy!

UBS notes that the US economy is slowing rapidly. After expanding by 3.2% in 2023, US gross domestic product (GDP), a measure of total economic output, slowed to 2.5% in 2024 and is expected to dip to just 1.1% in 2025. For comparison, the long-run average GDP growth rate for the US economy is around 3% p.a.

Looking further forward, UBS forecasts that GDP will stabilise around 1.6-1.7% through 2026-2027 – which means we’re on track for around half of the US economy’s typical growth for the next few years.

Why? The major issues cited by UBS are:

• Consumption growth is cooling under the weight of higher borrowing costs.
• Manufacturing is shedding jobs, and business investment intentions remain weak.
• Government spending and fiscal stimulus are no longer the supportive forces they were two years ago.
• Tariffs / retaliatory tariffs and slowing global free trade and threaten US exports.

For those of you whose brains just synapsed and flashed back to Year 11 Economics: GDP = Consumption + Business Investment + Government Spending + Net Exports. Yep, oops – 4 strikes and the US economy is OUT!

Policy missteps are beginning to bite 😬

Some would call me a drama queen if I said that President Trump’s tariffs are at the heart of all the US’s GDP woes. Well, let me say this: Tariffs are very likely at the heart of the sharpest pressures on US economic growth.

And UBS’s report backs me up. It notes that the effective US tariff rate has jumped sevenfold, to roughly 16%, driving up the cost of imported goods for consumers and businesses. This threatens to dent real incomes, and with savings buffers eroding, households are already feeling the pinch. UBS highlights that real consumption growth – the biggest component of GDP at around two-thirds – is slowing to about 2%.

For businesses, tariffs are pushing up input prices, weighing on confidence and investment. As the bank bluntly puts it: “The business sector of the economy seems likely to suffer from the tariffs.” On trade, UBS cautions: “the announced tariff actions are large enough we expect them to set in motion sizeable reordering of the United States’s trading relationship with the rest of the world and be a headwind to growth into 2026.”

Then there’s Trump’s immigration policy… Oh, don’t get me started 🙄 (you can’t ship out a big whack of your workforce and not expect some nasty consequences). UBS agrees here too, noting that changes to immigration policy are slowing population growth and shrinking the labour force. That lowers the economy’s “speed limits,” it proposes. Translation: With fewer workers available, potential GDP growth gets capped – meaning any given pace of expansion generates more inflationary pressure.

Put it all together, and you’ve got a stagflationary shock – higher prices, weaker demand. And if you asked US Federal Reserve Chairman Jerome Powell what keeps him up at night, it would be just that: Stagflation. It’s the ultimate bane of a central banker’s existence because its impacts on the economy are severe and it’s notoriously difficult to fix.

Can policymakers respond?

Attention now turns to whether Washington can offset these headwinds. On the fiscal side, UBS finds little reason for optimism. While new tax cuts appear supportive at first glance, they are likely to be offset by the negative impacts of tariffs and spending cuts, leaving the deficit to widen and limiting growth benefits. State and local government hiring is also slowing, further reducing the fiscal contribution to economic growth.

For the Federal Reserve, the dilemma is even sharper. Tariffs push up prices but sap demand and hiring. UBS writes: “The tool of the federal funds rate won’t stop cost-push price increases from tariffs. But it would make a weakening labor market even weaker.”

Still, rates are expected to fall to cushion the economy. UBS is forecasting the Fed will lower its funds rate from the current 4.25%-4.50% to 3.4% in 2026, and to 2.9% by 2027. Ultimately, the Fed will be forced to choose between tolerating higher inflation or risking higher unemployment. UBS argues it will choose jobs: “The FOMC will worry about inflation but likely react to the labor market slowdown when it becomes necessary.”

In short, investors should not expect fast or decisive relief. With inflationary constraints still in play, the Fed is likely to be reactive rather than proactive.

Conclusion: Time to get out the popcorn (and brown underpants!)

So where does that leave us? UBS’s forecasts underline a US economy that’s losing momentum – slowing growth, sticky inflation, and with policy missteps compounding the risks. What matters most for investors now is the policy response.

All eyes will be on the Fed tonight. The market has already priced in a 0.25% cut to the Fed Funds Rate due at 4:00 am Sydney time, but the real suspense lies in what Chairman Jerome Powell says at his press conference at 4:30 am. Will he hint at a path of deeper easing, acknowledging the threats of tariffs and fiscal drag? Or will he play hardball and signal wariness toward the looming inflationary threat?

The market response to either scenario is likely to be very different – euphoric relief in one case, downright soiling the bed in the other. Either way, the bottom line for investors today is clear: Prepare for volatility!

This article first appeared on Market Index on Wednesday 17 September, 2025.