The U.S. economy slows because of tariffs, but there are no signs of recession

The sectors benefiting from Trump’s tax breaks are pharmaceuticals, autos and utilities. The halt to illegal immigration is putting a brake on rents and bringing inflation down.

by Alberto Conca, manager of the Zest Quantamental Equity fund

In recent weeks, geopolitical developments have dominated the stage. However, it is important not to lose sight of the evolution of the main macroeconomic variables. For this reason, we have decided to analyse the potential impact of tariffs, as well as the outlook for inflation and consumer spending in the United States over the coming months.

Tariffs will undoubtedly affect U.S. economic growth, even if they are unlikely to trigger a recession. Assuming a global tariff of 10% and a tariff of 30% specifically applied to China, growth expectations for 2025 are forecast to fall from +2.2% at the end of 2024 to +1.4% by the end of 2025. It is important to stress that these estimates are highly volatile and difficult to predict, especially given President Trump’s frequent U-turns on previously announced decisions. As a result, this slowdown should weigh on corporate earnings for the S&P 500, which have already been revised down in recent weeks. However, there are currently no clear signs of an imminent recession. Rather, the U.S. economy may have entered a slowdown phase, driven largely by the issue of tariffs.

As a counterbalance to the negative impact of tariffs, the Trump administration has recently announced its intention to introduce the "Big Beautiful Bill" (BBB), a package of tax breaks and tax cuts. However, this new legislation is expected to have a more limited effect on corporate earnings than the tax cuts introduced during Trump’s first term, and the benefits will mainly be seen in specific sectors. In particular, in terms of capital expenditure (CapEx) and research and development (R&D), the sectors likely to achieve the largest tax savings on free cash flow are pharmaceuticals, autos and utilities. Taking into account the combined impact of tariffs and the "Big Beautiful Bill", the pharmaceutical sector stands out as the main beneficiary, with revenue growth expected at +2% year on year.

On the household side, the "BBB" should have a decidedly positive effect, almost comparable to the levels seen in 2018–2019. However, the overall burden of tariffs risks outweighing these benefits. In fact, 60% of low-income households will be hit disproportionately by the new tariffs, losing more than 1% of their current purchasing power. By contrast, the impact on high-income households will be virtually negligible.

Turning to inflation, to understand recent dynamics it is necessary to start with immigration, since the two phenomena are closely linked. If we look at the share of people born abroad both in the U.S. workforce and in rental housing units between 2020 and 2024/25, in both cases it is clear that their growth has far outpaced that of the overall population. This trend, particularly with regard to demand for rental homes, has pushed rents sharply higher. These elevated levels have persisted over time, exerting significant upward pressure on the overall inflation rate.

Since Trump’s election, the flow of illegal immigrants entering the country through the southern border has fallen sharply. This trend should have a mechanical effect in pushing rents lower and, as a result, in reducing inflation. As rental contracts expire and are renewed at smaller incremental rates (inflation measures the year-on-year change in prices, not the price level), the rents component, which accounts for around 35% of the inflation basket, will exert a significant disinflationary impact on overall inflation. The Consumer Price Index (CPI), excluding the rents component, has been running at around 2% for more than a year. This analysis could prompt the Federal Reserve to cut interest rates as early as its next meeting in July, despite market expectations pointing to the first cut in September.

Finally, on the consumer side, households currently appear to be in a solid financial position, if we look at the relationship between net housing wealth and consumer spending. This indicator can be used to assess households’ potential to tap home equity through borrowing (home equity loans) as a way of boosting consumption. Naturally, on the other side of the equation, this would require both a reduction in interest rates by the Federal Reserve and an easing of credit standards by banks, two factors that in recent years have severely limited lending activity.

Health Care - The relative performance of the Healthcare sector versus the S&P 500 from October 2023 to today has been significantly negative. This dynamic is also clearly visible when looking at the relationship between the sector’s three-year compound annual growth rate (CAGR) and that of the S&P 500. The sector is currently at oversold levels, almost two standard deviations below the historical average, an indicator that highlights the extremely negative momentum of the past three years. This situation could act as a catalyst for potential outperformance by the sector in the coming months or years. In addition to the negative performance, two further factors support the possibility of a rebound: the growth estimated for the next two years and valuations. Healthcare is the second-fastest-growing sector expected, surpassed only by technology, and is very attractive in valuation terms. The free cash flow yield of the Healthcare sector stands at 4.78%, around 170 basis points above the yield on two-year Treasuries, once again underlining the excellent opportunity offered by the market. Moreover, given the high market valuations and the defensive nature of the sector, investing in Healthcare can also be seen as a way to reduce portfolio volatility.

Finally, regarding the S&P 500, the year-end estimate in the absence of recession stands at around 6,100 points. As of today, the index is very close to that level and, over the coming months, depending on where earnings growth settles, we could see fluctuations between 5,700 and 6,300 points. Another reason why we may see volatility in the months ahead, with the S&P 500 moving within this range, is the July 9 deadline for Europe to reach a tariff agreement with the United States. If the talks end positively, the market will likely remain resilient, ignoring any negative geopolitical news. This resilience would be supported by the six-month percentage change in consensus earnings estimates over the past twelve months, which remains very high.