US Year-End Economic Update

Foreign. Welcome back, everyone. My name is Jeremy Cote, and you're listening to Iona Asks. In today's episode, we take a deep dive into the shifting landscape of the American economy at a moment defined by uncertainty and bold policy choices. From President Trump's sweeping trade war and historic fiscal overhaul to growing stress signals in US credits and consumers consumer markets, the economic narrative of 2025 is anything but straightforward. We'll explore what these developments mean for growth, inflation, financial stability, and the delicate balance of institutional independence, specifically the Fed. We'll also look closer to home, specifically at how Canada is navigating this turbulent environment. And what are the latest developments on the upcoming USMCA trade deal renegotiations? To discuss this very interesting episode today, we are joined by Brett House, a professor in the Economics division at Columbia Business School. His research and writing are focused on macroeconomic and international finance, with interest in fiscal issues, monetary policy, international trade, financial crisis, and debt markets. Previously, Professor House was deputy Chief Economist at Scotiabank and worked at Goldman Sachs and the World Bank. Professor House is also a fellow with Canada's Public Policy Forum and a senior fellow with the University of Toronto's Munk School of Global affairs and public policy. America's 2025 experiment can Trumponomics Deliver? Brett, thank you very much for joining us today. It's great to be with you. Thanks for having me. It's our pleasure. Well, I'd like to first start by maybe discussing a little bit of current state of the American economy. So everyone, we're all aware President Trump launched an international trade war on all fronts in March 2025. Economists were anonymous that this decision would would have negative consequences on the American economy. Specifically, many had anticipated that the cost of those tariffs would be shifted on American consumers. Yet inflation measures have remained quite steady at around 2.83%. My first question for you, Brad, is what can explain the relative stability of inflation indicators in the U.S. well, before we go into inflation indicators, I'd like to take a step back and look at where the US economy was at the end of 2024, just prior to the arrival of the Trump administration. It's worth remembering that the American economy was already pretty great and didn't need to be made great again. We came off a year of 2.8% growth in 2024 when we had anticipated growth was going to be either very low or flat with an appreciable increase in unemployment. During that year, we didn't see that. We ended up seeing a year of very strong growth with near historically low unemployment rates. And so we came into 2025 with a lot of positive momentum underneath us. And we also had declining rates of inflation with expectations that inflation would continue to come down over the course of 2025 to close to the 2% target in consensus forecasts that the Fed maintains. We also anticipated growth in 2025 would slow down, but what we've seen is growth has slowed more than anticipated as we continue to navigate the uncertainty created by the pointless trade war that the Trump administration has launched. And the trade war itself has bled through into higher inflation. So to your question, why has inflation not been higher? I think what one has to look at is what would inflation have been without the trade war? And we had very clear indications it was likely to come down to around the 2% Fed target. And in fact, it is not just held higher than anticipated, but moved back up toward 3% in both core and headline terms. So inflation is certainly being spiked by the tariffs. If you look at traded goods prices versus non traded goods prices, you see a clear distinction in their inflation measures with a bigger increase in traded goods prices, rates of increase. You also see non traded goods prices being pulled up along with them because the tariffs and the price increases that they are creating on traded goods is providing cover for non traded goods producers and sellers to bring up the prices they're charging as well. So, you know, the White House would have us believe that tariffs have not been inflationary when in fact against the counterfactual we had to expect this year. They certainly have been. Right. Yeah. It's definitely a tricky situation for the Fed to manage. On the one hand, kind of still like sticky inflation measures and as well like slower growth than first anticipated, like you just mentioned. I also want to touch briefly about like employment numbers. Recent employment indication figures have been like, somewhat disappointing. Specifically, I'm thinking about August, the numbers that came out well below projections. Is this a warning that the Trump administration should be attentive to when regarding when looking at its trade policy? Well, the employment numbers and the jobs market more generally is certainly a combination that is the kind of canary in the coal mine or economic bellwether of where things are going and where they're likely to be in the near future. So every political regime or government should be watching them closely, in part because the labor market is the best indicator of where consumer sentiment is likely to go. People don't spend if they don't have a job. And we know consumption is by far the biggest component of the expenditure side of gdp and the, the production side of GDP is dominated by the services sector, which is labor intensive. So we look to the labor numbers as a good indicator of the health of the economy because it is the biggest and earliest indicator of where those big components of production and income are likely going. Yes, absolutely. Most recent employment figures are also being put under question following the government shutdown and the implications that it had for the Fed and the Bureau of Labor Statistics. So I guess we'll see more over those signals over the coming months. Yeah. I would say though that we need to balance the impact of the government shutdown with a recognition that we already had great concern about the data following the dismissal of the Bureau of Labor Statistics chief, which was an incredibly political move and the kind of interference with the independent collection of gold standard statistics that we would typically see in an emerging market crisis country where there is an unwillingness to face up to the reality of data. This is reminiscent of the kind of interference with the statistical agency we saw in Argentina in the early and mid beginning of this century as they tried to falsely claim that inflation was smaller or lower than it actually was. We've seen the same kind of interference with statistical agencies in Turkey and Greece. This is not the kind of behavior we expect from the world's generator of the reference risk free asset or the largest economy in the world or the so called bastion of democracy. The US holds itself up as a view. Right. Interesting point you bring up there. I think the basis of modern monetary policy is monetary policy independence and of course having political influence or interactions is never well interpreted by markets. Speaking of markets, it brings me to my next topic. Investors have been quite worried about the recent developments in the US auto industry. Specifically we've seen the collapse quite spontaneous collapse of Tricolor, a used car seller and sub subprime auto lender as well as First Brands and auto parts supplier which have put the the finance industry on edge. You you've Specifically, how critical are those two collapse for the US banking industry? Is there a systemic risk? Well, those two firms were not critical to the US financial industry nor were they systemic in their implications. But they are important because they may, like the labor market data, be an indicator of the underlying health of the economy that is not being captured by some of our bigger and broader aggregates. We typically look at auto financing and stress within that part of the credit market as an indicator of incipient problems in the US economy, particularly problems facing relatively low or lowering middle income households. And that's because we generally think those households will default or delay payments on automobile financing. The last amongst all of their potential debts. So if we see rising delinquencies in auto credit is a sign that there is mounting financial stress for low and middle income households in the United States. Because if you default on a car loan and lose access to your vehicle, that typically means you're not going to be able to get to work in a country with poor public transit and the rest of your financial well being is likely to go downhill quickly as a result. So you know, we have traditionally seen low and middle income households in the US prioritize staying current with their auto loans and when we see indications that they're not able to do so, that is typically a sign that those households are being incredibly stressed by current economic conditions. So we look at first brands and tricolor not as systemically important institutions or organizations in and of themselves and their trouble as indicative of knock on effects that will affect the entire financial industry, but rather as early signs that there is likely to be greater stress than some of our big aggregate numbers imply. Yeah, to reuse your expression from earlier, another cannery in the coal mine, this time for household finance. Exactly. There are a few canaries singing at the same time in balanced views. Though you might also note that the economy continues to perform a bit better than we might have anticipated in the midst of an erratic tariff war, unpredictable policy from the White House, a general slowdown from the last years of the pandemic reopening and the creation of some stress in different parts of the debt markets. You know that that is all I think being held aloft by incredibly large fiscal deficits from the US government. We know they're north of 5% of GDP. And on the estimates and projections of the Congressional Budget Office they're expected to go towards 6 to 7, almost to 8% of GDP over the next decade, which is unprecedented in times that are not marked by crisis or war. So when folks say, well, economists were too pessimistic, we haven't seen the kind of disruption in the economy and growth more generally that they said would happen as a result of the White House's policy package. I think that is absolutely missing the point. The reason why the US economy is remaining in an expansionary phase is because fiscal policy is being historically stimulative at a time when it doesn't need to be. Right. So you've brought up quite a few points here and I just want to circle back. So I mean, on the one hand we have negative signals from employment numbers, a poor indication of employment growth, as well as difficult position of some of subprime household finances. At the same time, the economy is showing is resilient. The American economy has been resilient, but you highlighted that it's mostly due to the expansionary fiscal spending. My question for you, Brad, is you've mentioned deficit reaching maybe 8% in the coming years. Is this sustainable? Well, the United States does continue to benefit from what some have called the exorbitant privilege of being the generator of the world's reserve currency and its most important risk free reference asset in U.S. treasuries. Large current account surplus countries such as China, Japan, Germany continue to send relatively cheap capital to the United States. And it is likely to be the case that the US will continue to find it itself more cheaply than would otherwise be the case for a smaller or less systemically important economy. It has to shoot itself substantially in the foot to change that. And it is certainly taking some shots right now, but it isn't close yet to shooting that foot off, metaphorically to the extent that that exorbitant privilege is likely to disappear anytime soon. Right. So this I think is a nice bridge to my next point. You're talking about this discussion about fiscal spending. So we know earlier this year the Republican administration has passed this historic legislation nicknamed by President Trump the One Big Beautiful Bill. So it's essentially extensive tax cuts amounting to about US$4.5 trillion directed to businesses, but most especially to high income earners for the most part. And it is making the American economy open to business, at least that's how President Trump has highlighted it. How is this new economic reality shifting the public debate around fiscal spending? Well, we're seeing a pattern where Republican administrations talk about caring about the deficit and getting spending down, but in practice expand deficits massively and do so on the back of both higher spending and lower taxes. And that combination in the so called One Big Beautiful Bill act, the O BBB A has led some to query whether the triple B in that name is potentially the US's new credit rating. The sustainability question that you asked earlier though, is unlikely to become acute at any time soon because that ability to borrow at relatively low rates means that the US is likely to remain capable of servicing its debt. Because our most basic sustainability criterion is a situation where the real rate of growth is higher than the real rate of interest on our debt. And the US is likely to sustain that equation for some time ahead. Right. You've brought up BBBs, perhaps becoming the new potential credit rating of the US. This like in the short term middle run or More longer term perspective. I think it's facetious in some ways, but I don't think it's impossible that we see another A lopped off the US Credit rating. Not just because debt is set to go from about 125% of GDP upward to around 175% over the next 20 to 25 years or so if we stay on our current trajectory, but additionally because the US Budgetary system between the Senate, the House and the White House has become dysfunctional. And so, you know, the real prospect of a temporary impairment or default in payments means that that double A is certainly in doubt. And we could see it slashed to a single A not because the US Is unable to finance itself, but because there is an ever present and ongoing concern that there may be an interruption in that financing. Right. It sure seems, at least for outsiders like me, that no one seems concerned of the ballooning deficit. Well, if we look over the last 30 years or so, it's usually been Democrat administrations that have brought the deficit to heel and then paid for doing so politically. It's worth remembering too that the last time the US Government ran a surplus was under President Bill Clinton. And so any notion that the Republicans think that they are the party of fiscal conservatism or probity is deeply challenged by their track record of the last 30 to 40 years. Right. So kind of speaking about like balance of power and the different jurisdiction of the American democracy, I want to talk about the institution independence. We know, we've talked a lot about the Fed recently. President Trump, as repeatedly mentioned, well, repeatedly pressured the Fed for more favorable monetary policy decisions which have left markets and economists anxious to say the least. As I mentioned earlier, central bank's independence is the root of effective modern monetary policy. So my question for you, Brad, is with President Trump recently telling reporters that he knows, he knows who he is going to pick to replace Jerome Powell at the Fed. How do you expect the market reaction to this potential friendly chairman appointee? Odds are apparently building that it might be Kevin Hassett. Well, it's unlikely that the next Fed chair is going to be as balanced in their perspective between hawkish and dovish tendencies as Jerome Powell. They will almost certainly skew to the more dovish or more permissive on inflation and prioritize the employment part of the Fed's mandate more closely. That is likely to be reflected in a tendency toward more rate cuts in the Fed fund target band that will bring down the short end of the yield curve. But as we have seen over the last year Markets simply don't buy the notion that inflation is under control, nor that these cuts are the right thing for the fulfillment of the Fed's mandate and the American economy. We've seen the longer end of the curve come up and I would expect the appointment of a dovish Fed chair to push the longer end of the yield curve on US Treasuries even higher. Which is a useful observation in understanding why, even if you get interest rates on the short end of the curve down by forcing through that appointment some cuts in the Fed's. Fed's target band, you don't get to control the rest of the yield curve. And the interest rates that matter for business and households are typically out at the 10 year tenor, where the yield on 10 year government bonds provides a reference rate for the major things like mortgage financing that account for the vast bulk of the debt held by American households. Right. You brought up some really interesting points there. So maybe to refine things a little bit with dovish reaction from the markets, do you expect sustained growth on equity markets for 2026? Well, I don't think the markets are responding dovishly. It is the expectation that the new Fed chair is going to be more dovish than Powell. That could certainly drive some continued expansion in equity markets. But it faces a headwall in those longer run yields going higher and increasing the cost of capital for firms. And the possibility that that starts to call into question from a discounted cash flow perspective the already incredibly stretched valuations that we see in US Equities. There is no period in the past when we have been at equity valuations like the ones we've seen where we have avoided a correction in the year thereafter. And so even if equities go higher in the next year, it would be very hard, even if I knew that were going to be the case, to advocate allocations to equities when valuations are as stretched as we see right now. Right. And kind of just circling back about this whole independence notion, I was keen to ask you if there are any lessons that other countries can draw from the current assaults on the American monetary policy independence. Are there safeguards for examples that Canada could adopt or should adopt going forward? Well, what we can see is that institutional independence and many of the guardrails that we have on political and policy norms are context specific. And despite efforts to entrench them in legal frameworks and even constitutional frameworks, they remain dependent upon the extent to which an administration is willing to defer to the courts, defer to the legislative branch in an appropriate way and is at all invested in norms, precedent, and reactive to a certain amount of public shame. Without those things in place, there is no independent framework for policymaking that is impervious to political pressure. And perversely, what the White House doesn't seem to understand is the more that they interfere with and try to browbeat the Fed into cutting rates, the harder they make it for the Fed to do so. Modern inflation targeting is centered around the Fisher equation, which simply says that the real cost of capital is determined by the nominal interest rate, less inflation expectations. And the more that you push up inflation expectations by limiting the extent to which the Fed has the political and social license to act to control price increases, the harder you make it for them to get inflation expectations under control, and therefore the harder you make it for them to bring nominal policy rates down. Right. So in a way, this could, what we're witnessing right now, could have really adverse implications for, for American inflation monitoring going forward. Well, you know, we haven't been at the 2% target for five years, and it is increasingly looking like the Fed no longer actually targets 2%. In fact, you know, if we look at the FOMC statement from the December 10th cut, they said explicitly in the first paragraph that inflation was higher than had been anticipated and was going up rather than down. And yet they cut interest rates. And that doesn't speak to a Fed that still believes in the 2% target. Right. And so, well, follow up question on this. Do you think that the Fed's mandate should or must be kind of reevaluated to either put that 2% target more, put more obvious, or is it fine to go forward with like a more like, flexible interpretation of the mandate? Well, if anything, what we'd want to see is a less flexible interpretation, not a more flexible one if we're serious about getting inflation down. And what we saw in August, in the wake of Jackson Hole, the Kansas City Fed conference that is often a focal point for policy pivots. Jerome Powell did announce at that point the unwinding of five years of average inflation targeting, which had been implemented in August 2020, again at Jackson Hole, where the Fed moved its point target at 2% to an average target in an effort to say to a world that still was not clear of even the first wave of the pandemic, that the Fed was willing to let the economy run slightly hot in order to push inflation expectations up and push the real cost of capital down to stimulate activity in the reopening from the onset of the pandemic. And Public health measures in the second quarter of 2020. Jerome Powell Unwound average inflation targeting in August this year with a view to becoming precisely less flexible rather than more so. By moving back to a 2% target, he was trying to bring inflation expectations down and inflation down by making the real cost of capital higher without having to raise the nominal rate of interest itself, which was and remains a political impossibility. So if anything, we've already seen a shift toward stricter inflation targeting and that is in some ways I think also an attempt to get ahead of the likely appointment of a very dovish chair. Right. Chair Powell, Chairman Powell kind of trying to set the House in order before, before leaving, before exiting. I think so. And you also saw that, you know, with the reappointment confirmation of the regional Fed presidents recently to try to make the suite of policymakers who rotate in and out of the fomc, the rate decision making body of the Fed, more impervious to appointments from the Trump administration. Right. Professor House, I see kind of time flying and I do want to quick quickly touch on my last topic for today's episode. I wanted to talk specifically about the trade renegotiation on the USMCA trade deal. We know it's very important for Canada. Roughly 75% of Canadian exports go to south of the border to the US So tremendous implications for the Canadian economy. And albeit we haven't, Canada hasn't completely avoided tariff. We still face like pretty favorable tariff rate of roughly 2.4%. It's one of the lowest in the world according to Oxford Economics numbers. Yet some prominent Western trading partners have been able to secure a trade deal with the US Specifically I'm thinking about Japan and the European Union. My question for you Professor House is what explains that we have failed where others have been, well, more successful? I don't think we failed at all. The so called deals are anything but. They are vaguely worded letter of intents that have none of the legal standing or clarity of traditional trade pacts or free trade agreements between countries. These are the whims of the White House that could be undone at any moment. So I don't think Canada has failed in not negotiating one of these so called deals. I think it has actually kept itself in an advantageous position where we benefit from the usmca. We may see some tariffs rolled back by the US Supreme Court. Which one? Well, any of the tariffs have been implemented under emergency powers, which are emergency powers delegated to the President by Congress which has the constitutional power on tariff setting in the United States framework, but has delegated some of those powers to the President to be invoked on an emergency basis. The nature of that emergency has always been questionable. There is no flood of fentanyl nor illegal immigrants coming across the Canadian border into the United States. If anything, we need to worry about the flow of drugs and weapons northward from the US To Canada. Additionally, the other so called sources of emergency that the White House has invoked are also in many cases inconsistent with fact. And so the Supreme Court may find that those emergency powers have been inappropriately activated and in so doing, you know, invalidate the tariffs that have been put into place, enforcement, the possible repayment of the revenue that has been generated by them. So by saving or negotiating time, power and energy for the USMCA review, I think we have, either by design or by good luck and circumstance, avoided getting into some fights that we may not have to have over tariffs that might be rolled back by the courts and that are ultimately of minor importance compared to preserving the market access that we have under the usmca. It is certainly the case that Canada can, you know, chew gum and walk at the same time and that we can work on diversifying trade while also prioritizing preserving the trade agreement with our most important trading partner. And I think we need to do both. There is no way in which we are going to substantially diversify away from the United States in the next five to 10 years. And so, you know, pursuing alternative arrangements with the rest of the world while at the same time engaging fully in maintaining the trade access we have to the United States now, I think are concurrent and critical roles. Right. Yeah. I mean, because we've seen Prime Minister Carney and his government repeatedly mention the importance of diversifying our export markets, which is, I mean, very important in itself. But I think it's also, and also in bringing those, what they refer to interprovincial barriers. Interprovincial trade barriers and effectively removing them. And whilst that of course is appropriate, it's also like it's somewhat irrealistic to believe that overnight we're going to be able to transfer all our exports to Europe, Asia, or just trade between US and Canada. Right. Given the distance involved and also the proximity of the US Market for so many businesses located next to the border. Yeah. I don't think anyone thinks we can do so overnight, but we must pursue the creation of opportunities to grow and diversify those markets. I think it's great that you touched on interprovincial trade barriers in Canada too, because we have been laughably bad at Bringing those down. Even with the existential crisis we face with the disruption of our trading relationship with the United States, the so called Canada Free Trade Agreement, which was meant to create freer trade amongst the Canadian provinces, has made very little progress in its fleshing out and implementation. We have seen a welter of bilateral and multilateral memorandums of understanding put in place amongst provinces. These are being held up as advances in reducing interprovincial trade barriers. I think we should be very cautious in celebrating them. Every time provinces do these bilateral or multilateral agreements between them, they may bring down trade barriers on narrow bilateral directionalities, but they create greater complexity for trade within Canada. At the same time, it should be the case that we don't need agreements between provinces for all of them to move in the same direction toward reducing these barriers. They're both explicit and implicit. Right. But it's, I guess we're facing. Now we're coming back to the issue of Canada facing quite a decentralized democratic system where provinces have somewhat, a lot of, a lot of powers. I think it's great that they have a lot of powers. What I am suggesting is that they should use those powers to make Canada into a more efficient market. I think, you know, we've heard Doug Ford in Ontario as a strong advocate for, you know, free trade with the United States and free trade within Canada. He should use his powers as premier of the largest economy in the country to really lead on that front. I think that would be far more productive than sending ads into the United States media market. Right. Professor, I do want to. I see we're already at 38 minutes and well, coming just really quickly finishing up on this trade deal topic. President Trump has suggested last week that he is considering walking away from the USMCA renegotiations with Canada and Mexico and let it simply expire. How should Canada interpret this threat and more specifically, how should we respond to it? Is it just another one of those baseless threat that President Trump has accustomed us to? I don't think it's a baseless threat, though. It's not the case that the USMCA is about to expire. It's going through a review that was foreordained at the five year point of its implementation. So, you know, we shouldn't be pedants about the terminology that the president uses and should take the substance of what he's saying, which is that throughout this review process, he is going to threaten either the end of the USMCA through a withdrawal that they can announce with three months or six months delay or the breaking up of USMCA into bilateral agreements between the U.S. and Canada and Mexico respectively. All of these things are going to be part of the noise around the renegotiation of the deal. I think we will see American companies and regions and states and cities on Canada's side speaking up for the necessity of retaining the deal. It's worth also remembering the renegotiation of NAFTA into ESMCA occasioned very few changes in substance. It was mainly changes in cosmetics. I don't say that for us to be completely Panglossian or overly sanguine about the prospects for a real disaster on the North American trade front, but we do know the bark is often bigger than the bite, right? Professor House, thank you very much. And thank you very much to all the listeners that joined us today for this episode where we discuss the overall state of the American economy as well as we briefly touched about debt and capital markets, fed independence as well as the latest development on trade renegotiations of the USMCA trade deal. Thank you very much, Professor. It was great to speak with you.