Nomura warns of US stagflation as growth slows, inflation looms

While US economic performance has been mixed since President Donald Trump took office, Nomura economists believe a slowdown in growth and a rise in inflation are coming. Lags are delaying the impact of US tariffs, and the devil is in the details. There is mounting evidence that stagflationary pressures are building.

The analysis suggests that, while current economic indicators might appear mixed, the underlying trends point toward increasing challenges ahead, requiring careful navigation from both policymakers and market participants.

The first quarter of 2025 marked a significant turning point, with GDP contracting by 0.2 per cent – the first negative print since the first quarter of 2022. While this decline was primarily driven by an extraordinary surge in imports that created the largest trade-related drag in nearly 80 years of GDP records, the underlying story is more nuanced. When volatile components are stripped out to examine core GDP through final sales to private domestic purchasers, a sharp slowdown from 2.5 per cent in Q1 to -1.0 per cent in Q2 is expected.

Despite initial concerns about a potential tipping point following April's tariff announcements, May's employment report showed resilience, with 139,000 new jobs, which was slightly above consensus. However, beneath this headline figure lies a more cautionary tale, as a substantial 95,000 downward revision to previous months and rising indications of layoffs suggest increasing vulnerabilities in the labour market.

Current inflation readings appear deceptively benign, with core inflation tracking the Fed's 2 per cent target over the past three months. However, Nomura analysis suggests this may be temporary. Survey data reveal that nearly a third of manufacturers and about 45 per cent of service firms plan to fully pass along tariff-related costs to consumers. This pricing pressure remains masked for now by elevated inventory levels, but could emerge more prominently as these buffers deplete.

While financial conditions remain loose and equity markets show strength, risks are building. The combination of potential stagflation, richly valued asset prices, and limited policy flexibility creates a challenging environment. Unlike previous periods of financial stress, both fiscal and monetary policy face constraints, the former from large budget deficits and the latter from rising inflation risks.

Nomura forecasts 2025 GDP growth at just 0.8 per cent, which would mark the weakest performance since 2009, excluding the pandemic-affected 2020. This outlook reflects the complex interplay of factors currently shaping the US economy, from tariff impacts to labour market dynamics and inflation pressures.