Replacing Fed’s Kugler Unlikely to Trigger Deep Cutting Cycle

Summary

• US growth is likely to remain below 1.5% over the next year or so due to immigration collapse and consumer debt stabilisation.
• The Trump administration is likely to react through fiscal stimulus as monetary policy will likely remain beyond its reach.
• Because the growth slowdown is partly supply driven, a fiscal stimulus could bring about broad-based inflation acceleration, which would limit the Fed’s ability to cut

Market Implications

• I still expect two-three 2025 cuts and at most one 2026 cut against markets pricing 2.4 and three cuts, respectively.

Immigration Supports Exceptional Consumption Recovery

Here, I argue GDP growth is likely to remain below 1.5% for the remainder of 2025, which is likely to elicit a policy reaction. But any policy stimulus could bring to the fore underlying, long-term cost pressures that would limit the Fed’s ability to ease.

During last week’s FOMC presser, Chair Powell noted that, ‘Consumer spending had been very, very strong for the last couple of years and – repeatedly, forecasters, not just us, had been forecasting it would slow down and now maybe it finally has.’ What Powell was referring to is that post pandemic, consumption has grown well ahead of pre-pandemic trends (Chart 1). This is extremely unusual. In the typical recovery, consumption never returns to the pre-recession trend, let alone rise above it (Chart 2).

This time, the exceptional consumption strength reflects two key factors.

First, the 2021-23 immigration surge that multiplied the number of consumers. Comparing growth of total consumption and of consumption per capita shows this, with the latter much slower than the former (Chart 3, due to data issues with the Census Bureau population estimates I have used NFPs as proxy for population). The administration’s clamp down on immigration implies slower consumption growth going forward (Chart 4).

Chart 1: Exceptional Consumption Strength	Chart 2: Post-GFC Pattern Is Typical
Chart 3: Immigration Surge Lifted Spending	Chart 4: Slower Population Growth Ahead

Debt dynamics was the second factor supporting the exceptional consumption recovery.

Debt Capacity Boosts Consumption Recovery

Large government transfers, fast nominal income growth and slow growth in mortgage debt have created room for an increase in consumer borrowings that has fuelled the post-pandemic consumption boom.

Consumer debt decreased during the pandemic, even though spending surged, especially on durables (Charts 5 and 6). This is because in 2020-21 consumers used very high government transfers rather than debt to fund consumption.

In addition, post-2022, nominal income growth has been faster than pre-pandemic, as the economy reopened, inflation accelerated, and the exceptional 2020-22 policy stimulus worked its way through.

Furthermore, after 2022 mortgage debt fell relative to income due to the mortgage lock-in effect. Lower mortgage debt created more room for consumer borrowing while leaving total debt lower relative to income than before the pandemic (Chart 7).

Chart 5: In 2020-21 Consumers Deleveraged…	Chart 6: …Despite High Spending
Chart 7: Lower Debt/Income Post Pandemic	Chart 8: Rising Debt Service Ratio

Consumption to Remain Weak

However, consumption has been flat since end-2024. This reflects the sharp decrease in immigration and consumers seeking to stabilise their indebtedness.

Even though total household debt has been falling relative to income since 2022, the household debt service ratio has been increasing since 2021 (Chart 8). This reflects the end of pandemic measures such as mortgage forbearance and, from 2022, Fed tightening. While the debt service ratio is still below pre-pandemic by the equivalent of 0.5ppt of income, households could have decided to stabilise their indebtedness (i.e., save more. The debt service ratio is available only up to Q1, debt service could have increased further in Q2).

These developments pre-date the current administration. Nevertheless, two policy developments have added downside risks to consumption. First, the surge in policy uncertainty has lowered consumer confidence and raised precautionary savings (Chart 9).

Second, the end of forbearance on student loans, while promoting more efficient college funding in the long run, is likely to weigh down on consumption. Starting in May, defaulted or delinquent loans have become subject to collections. Also, loan status has started being communicated to credit bureaus and to impact credit scores. The main impact of the measures so far has been a sharp increase in student loans delinquencies. DoE loan collections have not increased much, yet (Chart 10).

In 2025 H1, quarterly consumption growth averaged 0.25% QoQ (Chart 11, the last data point, Q3 2025 is a forecast). The above discussion suggests consumption could remain around current levels and contribute less than 0.75ppt to QoQ SAAR growth for at least a few more quarters.

However, capex growth has been strong, 1.5% QoQ on average, or a contribution to GDP growth of 0.9% QoQ, in H1. This partly reflects the AI revolution and could persist as it seems in line with previous capex booms (Chart 12). Altogether growth could remain sub 1.5% QoQ for the next few quarters.

Chart 9: Higher Households Savings Rate	Chart 10: Higher Student Delinquencies
Chart 11: Consumption Growth to Remain Weak	Chart 12: Capex Boom to Persist

The administration is unlikely to sit still if the mediocre growth rate I expect materialises.

Administration Could Stimulate Economy in 2026

I think the administration is unlikely to find sub-1.5% growth acceptable. It would certainly be lower than Treasury Secretary Bessent’s ‘3-3-3’ plan: boosting growth to 3%, lowering the deficit to 3%, and increasing US energy production by the equivalent of 3mn b/day.

The administration also hopes its tax cuts and deregulation will cause a boom ahead of November 2026’s mid-term elections.

Therefore, I expect a policy reaction, most likely fiscal. This is because monetary policy will likely remain out of the administration’s reach. President Trump is about to appoint a new Fed governor who will be one of 12 FOMC voting members. It is unclear whether Trump will appoint another governor when Powell’s mandate expires in May next year as Powell could decide to remain as governor. And while Trump will choose the next Chair of the Board of Governors, their influence on the FOMC could be limited. I think monetary policy is likely to stick to the Taylor rule (Chart 13).

A fiscal stimulus appears more likely. It is unclear how much deficit the administration is currently targeting for FY2026 because the ‘One Big Beautiful Bill’ (OBBB) and its Congressional Budget Office (CBO) scoring have been assessed with unchanged tariff policies (Table 1). This likely was intended to give Trump a completely free hand in tariff negotiations.

In addition, this creates great uncertainty over where fiscal policy is headed. For instance, the CBO expects the OBBB to increase the FY2026 primary deficit by $478bn relative to its January 2025 baseline (Table 1). But higher tariff revenues could easily fund this increase in the deficit. In June tariff revenues were $26bn, up from the $8bn monthly average in FY2024. Average monthly tariffs of $40bn would be enough to fund the OBBB-implied increase in the FY2026 deficit. Whether $40bn is realistic depends on the economy’s reaction (beware the tariff Laffer curve!) and on Trump’s policies.

Regardless, I expect the administration to enact a stimulus if growth is still below 1.5% by end-2025. It could take the form of cash handouts to households or of temporary tariffs relief. Senator Hawley has already introduced legislation to send tariff rebate checks to households.

The risk associated with a fiscal stimulus next year is that the growth slowdown is partly supply-driven. Due to the immigration clamp down, labour supply growth could slow to 0.4% YoY at end-2026, from 1.3% currently. In such an instance a positive demand shock would bring underlying, long-term cost pressures to the fore. Core goods, food and energy prices have been increasing and could become a broad-based inflation acceleration if the administration stimulates the economy (Chart 14).

In such an instance, the disinflation the Fed expects in 2025 would not materialise and the Fed, that currently expects one 2026 cut, may be unable to cut three times as markets expect.

Table 1: Tariffs Could Easily Fund OBBB but Will White House Let Them?

Chart 13: Fed to Stick to Taylor Rule	Chart 14: Cost Pressures Are Emerging

Market Consequences

I still expect two-three 2025 cuts and at most one 2026 cut against markets pricing 2.4 and three cuts, respectively.

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