We remain optimistic about the economic (and therefore market) outlook for 2025, although we are closely watching a variety of indicators for signs of weakness. Some indicators, like credit spreads, CEO confidence, small business optimism, equity market breadth, and the labor market remain quite strong. Others, including uncertainty around administration policies like tariffs and immigration reform and inflation expectations are more concerning. With both equity and fixed income valuations on the high side, any hiccup in growth could be penalized in the markets. As long as the underlying economy remains solid, such a hiccup would not be overly concerning. Inside we examine the potential magnitude on the economy of two presidential priorities: DOGE and immigration.

Key Data Points to Watch in March

• Atlanta Fed GDPNow. In late February, markets were surprised to see the Atlanta Federal Reserve’s GDPNow indicator decline to -1.5% for the first quarter of 2025. The decline was driven by a surge in imports, presumably as firms raced to import goods prior to tariff implementation. We will watch to see if this indicator rebounds as tariff uncertainty abates – this should be a one-time effect
• Federal Reserve (“Fed”) meeting March 18-19. We saw in the January meeting minutes that Federal Open Market Committee (FOMC) participants remained concerned about higher inflation. Subsequent to the January meeting, reports on both Core CPI (3.3%) and Core PCE (2.5%) were notably above the Fed’s 2% target. We therefore anticipate that unless the labor market materially weakens, the Fed will remain on hold in March
• Inflation March 12 (CPI) and March 28 (PCE). The Fed will be watching inflation data as one input to their decision on interest rates; a CPI or PCE report closer to 2% could give the Fed cover to resume lowering the Federal Funds Rate
• Jobs March 7. The average of new monthly nonfarm payrolls has remained fairly steady at between 150,000-200,000 for the last two years. Our positive economic outlook hinges on a continued strong labor market. The estimate for February jobs of 160,000 is consistent with that range and supports decent 2-3% GDP growth
• 2025 earnings estimates. For the past two years, estimates for S&P 500 2025 and 2026 earnings have remained roughly stable. If the economy slows, we would expect estimates to begin to decline as companies and analysts reflect a slower environment. Currently, forecasts are for 10% growth in 2025 and 14% growth in 2026

February Takeaways:

• Fourth-quarter corporate earnings grew 13%. This was about 6 points higher than analysts had expected and reflects breadth across many sectors. Communications Services led the pack, with particularly strong earnings growth from Fox Corp, Netflix, and T-Mobile, while Consumer Discretionary companies also reported strong earnings growth, led by Amazon, CarMax, and General Motors
• Bond yields dropped, reflecting heightened uncertainty. The Bloomberg Aggregate Index appreciated by 2.2% while the Bloomberg Intermediate Government/Credit Index appreciated by 1.4%. Credit spreads widened by about 0.3%, but remained at the low end of their historical range, indicating that bond investors are not overly concerned about potential credit quality deterioration
• US equities declined. After a 2.8% increase in January, the S&P 500 Index took a breather and declined by 1.3%, bringing the year-to-date return to 1.4%. Small- and mid-cap indices performed worse, and are down 3.0% and 0.7% year-to-date respectively
• International equities appreciated. The MSCI EAFE Index appreciated by 2.0% in February, bringing its year-to-date performance to 7.3%. This does not quite get the index back to September 2024 levels, as the index had declined by 8.1% in Q4 2024

Sizing the Administration Policies in the Context of the US Economy

Many clients are asking about the potential impact on the labor market of two administrative initiatives: the Department of Government Efficiency (DOGE) and revised immigration policy. In reality, savings targeted by DOGE are unlikely to have a materially negative impact on the economy (or a materially positive impact on the deficit). On the other hand, a significant change in immigration policy could materially impact the labor market.

One important pillar underpinning the US economy since the pandemic has been the labor market. Unemployment is currently 4.0%, near all-time lows, and there have been more open jobs than unemployed workers for nearly four years, since April 2021. New jobs have been created at a pace of 150,000 – 200,000 per month.

DOGE has announced an intent to eliminate at least 200,000 federal government jobs (of 2.3 million total) and has announced approximately 95,000-100,000 so far. Of these, 77,000 are federal workers who accepted a payout analogous to a severance package and will receive pay until October 2025. The other roughly 20,000 is split between US AID employees and probationary employees (those who have been in their role for less than a year). Note that average annual attrition of federal government workers is about 140,000, so in scale, this is between one and two years of normal attrition. We believe the 2025 deferred resignations partially pulled forward some folks who planned to retire anyway.

To put this in the context of the overall economy, eliminating 200,000 federal workers would be about the same as having a single month without job growth. While this could temporarily crimp GDP by perhaps 0.5% and raise unemployment perhaps by 0.2%, this in itself will not cause the economy to nosedive. Economists estimate the largest impact to land in late 2025 / early 2026, with the effect largely gone by 2027. Put differently, federal workers comprise 1.9% of all US workers and over the past several years have comprised about 6% of all new jobs created. There are about 2.6 contractors for each federal employee; cutting contractors in addition to federal employees would amplify the direct impact of cutting only workers.

Will the DOGE cuts balance the budget? DOGE has initially targeted $100 billion in savings, comprised of not only fewer federal employees but also canceling or not renewing subscriptions, contracts and contractors. The federal budget of $7.3 trillion has grown to approximately 23% of GDP, (although most of this is Social Security payments at $1.5 trillion, Medicare at $1 trillion, and Medicaid at $900 billion). Federal employees totaled $293 billion in combined compensation in 2024 (whitehouse.gov). So the $100 billion in savings equates to approximately 1.5% of the budget. According to the Congressional Budget Office, the US will run a deficit of approximately $1.9 trillion in 2025, so cutting $100 billion would reduce the deficit by perhaps 5%.

Immigration on the other hand has the potential to have a larger impact on the labor market and economy than eliminating federal workers, although the impact will depend greatly on the speed and magnitude of immigration limits and/or deportations. Immigrants in the US comprise approximately 41 million people, of which 30 million are documented and 11 million undocumented.

The impact on the labor market of closing the country to new immigration would be materially larger than that of DOGE, as approximately 2 million people immigrate into the country each year. New jobs created in the US each year have averaged between 2 million and 4 million jobs per year, so shutting off the flow of immigrants even without deportations will deprive the labor market of a year’s worth of participants. Losing these workers in a 4.0% unemployment environment can be problematic: we expect that wage inflation – which has averaged about 4.5% over the past few years – would accelerate, triggering higher inflation across the board.

In addition to a broader macroeconomic impact, certain industries are much more reliant on immigrants (both documented and undocumented) and will be hardest hit: construction, agriculture, and hospitality. We may expect higher inflation in these fundamentally service-driven industries.

That said, there are many ways that policy could be enacted, and some would be less material than others. For example, if the administration merely lets 3 million existing humanitarian visas expire without renewal and without granting new ones over the next few years, the impact on the labor market would be much less.

The strong labor market has been a key component of the positive economy over the past several years. While both DOGE and immigration reform have the scope to negatively impact the labor market, we believe the greater risk comes from potential modifications to immigration than from DOGE cuts. With fewer immigrants, unemployment might decline in the short term – as fewer workers are available to fill existing jobs – but in the medium term the loss of demand from these households would likely slow GDP. We will continue to assess developments as they arise and currently believe that economic risks are manageable.

Disclosures