Have Tail Risks to the US Economy Increased?

Yes. The range of possible outcomes for the US economy has widened, with greater chances of both positive and negative tail events. US real GDP has grown by approximately 2.5% per annum over the last ten years, and our expectation is that US growth this year will be moderately below that trend, which is broadly in line with the current consensus expectation of 2.4%. While we have previously seen little significant risk of positive growth surprises, recent policy announcements and proposals have introduced a more material risk of stronger-than-anticipated growth. At the same time, left-tail risks have also increased due to continuing stasis in the labor market, rising inequality, and escalating geopolitical uncertainty. This shift toward a fatter-tail distribution of outcomes reinforces both the case for diversification and our recommendation to moderately underweight US equities and the US dollar.

Turning first to the sources of upside risks to growth, greater US government support is one potential driver. This comes despite an already elevated and expanding budget deficit, with the fiscal impulse expected to swing from a drag to a boost in the first half of 2026 because of the One Big Beautiful Bill Act. In this context, US President Trump has proposed increasing the military budget by approximately 50%, to $1.5 trillion. If this proposal finds support, which is not certain, it may not materially affect the economy until 2027. However, at more than 1.5 percentage points of GDP, it would nonetheless be sure to have a more immediate financial market impact.

To boost growth more immediately, ostensibly influenced by low approval ratings ahead of the mid-term elections, the Trump administration has taken several actions. A presidential directive instructed Fannie Mae and Freddie Mac to purchase $200 billion in mortgage-backed securities, which has helped bring 30-year mortgage rates down toward 6% and aims to stimulate homebuyer activity. Lower mortgage rates could also support discretionary spending, a goal further targeted by the proposed 10% cap on credit card rates. This proposal follows the Federal Reserve’s Senior Loan Officer Survey showing that banks are now tending to ease lending standards for consumer loans after a prolonged period of tightening.

Furthermore, political pressure on the Fed to deliver easier monetary policy has intensified to a degree not seen in recent decades, with President Trump and other administration officials advocating for rate cuts. Our base case is that the Fed will remain independent, with economic data remaining the primary driver of monetary policy decision. Nonetheless, the chances of political considerations influencing policy assessments have increased at the margin. Even without these various policy initiatives and interventions, financial conditions in the United States have been steadily easing in recent months. This broad-based easing, inclusive of appreciating risk assets, falling yields, and a weakening dollar, was already shaping up to be an activity tailwind.

Despite recent positive developments, left-tail risks persist, as the US economy remains distinctly “K-shaped.” This term refers to a scenario in which high-net-worth households continue to benefit from asset appreciation and strong wage growth in knowledge sectors, while low- and middle-income earners face increasing pressures. Indicators such as extremely low consumer sentiment and personal savings rates highlight this divide, as does the fact that wage growth for the lowest quartile of earners has lagged all other groups for the past 15 months. Aggregate data can mask this underlying fragility. While headline consumption and growth figures remain positive, the widening gap between the “upper” and “lower” arms of the economy creates a brittle foundation. As a result, overall growth may obscure systemic vulnerabilities.

Several labor market indicators highlight these underlying vulnerabilities. Over the past three months, nonfarm payrolls have declined by an average of 22,000 jobs. While private payrolls have increased by 29,000 jobs, only slightly below most estimates of the new break-even level, much of this growth is concentrated in the education and healthcare sectors. Although the recent rise in the unemployment rate has been modest, there are signs that the gig economy may be concealing deeper weaknesses. This is evidenced by increases in the number of people working part-time for economic reasons, the unincorporated self-employed, and those holding multiple jobs. Though layoffs remain relatively subdued, there has been a modest uptick. The ongoing decline in job openings, hires, and quits also suggests a lack of confidence among both employees and employers. The key concern is that if layoffs begin to accelerate, downside risks could quickly become more pronounced.

Recent developments have shown that geopolitics also remains a significant concern, contrary to hopes for a more stable outlook. On the trade front, the threat of new tariffs has resurfaced, even if some have since been revoked, underscoring persistent policy uncertainty that continues to weigh on hiring and investment. Immigration policy also contributes to this uncertainty, creating insecurity for lower-income earners and their employers. Additionally, the proposed cap on credit card rates, though intended to support consumers, could lead banks to restrict credit. This would pose further challenges for those most vulnerable in the economy. Indeed, even if other policy measures succeed in boosting growth in the short term, their impacts on markets are not guaranteed to be positive. For example, investors may push yields higher in response to renewed inflation pressures and a growing deficit, potentially dampening the benefits of these policies.

Taken together, both upside and downside risks to the US economy have become more pronounced in our view. Given the increase in tail risks, diversification should continue to serve as a guiding principle for investors, a point we emphasized in our 2026 Outlook. In this context, we continue to recommend maintaining a modest underweight to US equities and USD exposure.