CICC: Focus on the downside risks of the U.S. economy

Recently, the U.S. real estate market, consumer confidence, and service sector activities have generally weakened, indicating that the optimism accumulated by the private sector after Trump's election is dissipating. We believe that the uncertainty surrounding tariffs, the tightening effects of government spending cuts, and the ongoing high interest rate environment are the main reasons for the weakening data. This also suggests that adjustments in public policy can bring about "growing pains," and the Trump administration is no exception.

Looking ahead, the fundamentals of the U.S. economy remain solid, but as headwinds increase, we are beginning to pay attention to the downside risks of economic growth. We maintain a more cautious attitude towards the U.S. economy until the headwinds dissipate or truly business-friendly policies (such as tax cuts, deregulation, and interest rate reductions) are implemented.

In the past week, U.S. economic data has performed poorly: the NAHB housing market index for February fell more than expected, reaching its lowest level since September of last year (Chart 1). The final value of the University of Michigan consumer confidence index for February has declined for the third consecutive month, hitting a new low since November 2023 (Chart 2). The preliminary value of the S&P services PMI for February was 49.7, falling below the expansion line for the first time in 25 months (Chart 3) .

These changes indicate that the optimism previously accumulated by businesses and consumers after Trump's election is dissipating. We believe the underlying reasons stem from three aspects: the uncertainty of tariff policies, the tightening effects of government spending cuts, and the ongoing high interest rate environment.

I. Uncertainty of Tariff Policies

Since Trump took office, tariff policies have been constantly changing. After previously issuing presidential executive orders on tariffs against Mexico, Canada, China, and steel and aluminum products [1], he instructed his team to conduct investigations into "reciprocal tariffs" [2]. On February 18, Trump announced plans to impose tariffs of 25% or higher on imported automobiles, semiconductors, and pharmaceuticals [3], and on February 19, he announced again that tariffs of around 25% would be imposed on imported lumber and forestry products [4]. Although these tariff policies have not yet been fully implemented, there is widespread concern in American society about the uncertainty surrounding tariffs. The U.S. Trade Policy Uncertainty Index has surged significantly over the past month, currently approaching the high levels seen in August 2019 (Chart 4).

The uncertainty of tariffs may reduce consumer and business confidence, interfering with their decision-making. On one hand, tariffs raise consumer inflation expectations, suppressing expectations for future purchasing power. The University of Michigan survey for February shows that consumers expect inflation to reach 4.3% over the next year, and their inflation expectations for the next 5-10 years have risen to 3.5% [5]. This indicates that consumers have widespread concerns that tariff increases will drive up prices.

On the other hand, tariffs increase business costs, lowering future profit margins and business confidence. We can already see signs of this from the NAHB survey [6]; since 32% of appliances and 30% of softwood lumber come from imports, builders have begun to worry about cost issues. Other builders have indicated that incentives offered to stimulate sales are weakening [7]. In February, 26% of builders lowered home prices, down from 30% in January, marking the lowest proportion since May 2024, with 59% using sales incentivesBelow 61% of January. For industries with high import relevance such as automobiles and semiconductors, tariffs will also be a significant challenge. The CEO of Ford recently stated that Trump's tariff policy will cost American automakers billions of dollars, potentially dealing a heavy blow to the U.S. auto industry.

II. The Contraction Effect of Government Spending Cuts

In the past month, the government efficiency department (DOGE) led by Musk has made rapid progress in cutting fiscal spending. First, Musk launched a "buyout plan" for federal employees, effectively promoting government layoffs. According to the "buyout plan," federal government employees who voluntarily resign before a specified time can receive 8 months of salary compensation, with the individual's salary and benefits continuing until September 30, and providing reductions in work arrangements.

Data shows that approximately 75,000 federal employees have accepted the buyout plan so far, accounting for more than 3% of the total federal workforce, and the 3% buyout rate far exceeds the normal voluntary resignation rate of 0.4% for U.S. federal employees during typical periods (Chart 5). According to DOGE's plan, the final federal government layoff rate may be around 5%-10%, which means that ultimately 100,000 to 200,000 federal employees may be forced to change jobs.

For the U.S. labor force population of 170 million, a scale of 100,000 to 200,000 is not large, but in terms of incremental impact, the addition of 2 million non-farm jobs throughout 2024 will still be affected by these departing employees, as their entry into the labor market will intensify competition. Additionally, the spillover effect must be considered, as the reduction in government size will also impact surrounding industries, such as contractors for government projects, government-related catering, office building leasing, technical support services, and more. Data shows that the number of initial unemployment claims in Washington D.C., where the federal government is located, has significantly increased since February, and some industries and economic activities related to the government in Washington D.C. are also facing varying degrees of pressure.

Secondly, DOGE has expanded the scope of its review of improper payments by the government, and mandatory spending will also face cuts. Improper payments refer to erroneous or questionable payments made by various federal departments, including waste, fraud, and corruption issues. According to data from the U.S. Government Accountability Office (GAO), the scale of improper payments by the U.S. government has been high since the COVID-19 pandemic, with approximately $235 billion in improper payments in fiscal year 2023 (Chart 6).

As DOGE's review scope gradually expands to mandatory spending areas such as healthcare and social security, these improper payments have been discovered one after another, breaking the market's previous inherent perception that livelihood spending is rigid and difficult to cut. As of February 17, DOGE stated that it has helped the federal government reduce fiscal spending by $55 billion, averaging about $2 billion per day, and this scale may continue to expand in the futureIn fact, DOGE's ability to cut spending has exceeded market expectations. Looking back to December last year when Musk formed DOGE, the market generally believed that Musk lacked political experience and would find it difficult to effectively push for spending cuts in Washington's complex political environment, but this has proven not to be the case.

Why has DOGE been able to quickly advance its work? We believe there are three reasons.

First, Musk has strong technical support. In the past, government financial account audits were time-consuming and labor-intensive, but Musk and his team possess cutting-edge artificial intelligence (AI) and computer technology, which may have effectively improved the efficiency and depth of audits, allowing them to identify hard-to-detect accounting loopholes. Second, they have gained widespread support from Republicans. From President Trump to Treasury Secretary Mnuchin, and most Republican lawmakers, there is a high level of recognition and active cooperation with DOGE's work, and they are pleased to see its rapid achievement of streamlining government and cutting spending goals.

Third, there is broad public recognition. DOGE continuously showcases through its social media accounts that it has found various loopholes, such as discovering that over 2,700 Americans aged over 200 are still receiving Social Security benefits, with the oldest being over 360 years old, which is longer than the time since the founding of the United States [14]. This kind of display helps to enhance DOGE's transparency and makes it easier to resonate with the public.

III. High Interest Rate Environment Hinders Real Estate Recovery

Although the Federal Reserve began its interest rate cut cycle last September, having cut rates by a total of 100 basis points to date, long-term interest rates have not significantly decreased, which hinders the recovery of the interest-sensitive real estate sector. As of February 20, the U.S. 30-year mortgage rate remains as high as 6.85%, continuously suppressing the demand for new loans to purchase homes (Chart 7). Due to the unexpected rebound in core CPI inflation in January, coupled with a rise in inflation expectations in February, we believe the Federal Reserve may delay the timing of interest rate cuts until the second half of the year, which will further dampen expectations for future rate declines. We mentioned in our report at the end of last year that the pace of decline in long-term interest rates during this rate cut cycle is significantly slower than in previous cycles, which will delay the timeline for a comprehensive recovery in real estate. This view has been confirmed by recent data.

On the other hand, high housing prices continue to suppress the purchasing power of buyers. Data shows that the median age of first-time homebuyers in the U.S. has risen from 46 years in 2019 to 56 years, and the proportion of first-time homebuyers has also dropped to 24%, the lowest level in over a decade [15]. Additionally, as mentioned above, tariff expectations have led real estate developers to begin worrying about cost issues, which may reduce developers' willingness to lower prices, resulting in an accumulation of new home inventory (Chart 8).

In some areas of the western and southern United States, a certain degree of housing sales stagnation has already emerged. Recently, U.S. luxury home developer Toll Brothers stated at its earnings conference that although demand in the high-end market remains healthy, the affordability constraints in the low-end market and the growing inventory are putting pressure on sales [16] Overall, the fundamentals of the U.S. economy remain solid, but as headwinds increase, the downside risks to economic growth may rise. Since Trump took office, due to the policy sequence of "first tariffs, then tax cuts, first saving money, then spending money," the tightening effect of adverse policies has been implemented intensively, which has already affected the confidence of businesses and consumers. Meanwhile, high interest rates suppress housing demand, further weakening the growth momentum of the U.S. economy.

We believe that against this backdrop, a comprehensive economic recovery may need to wait for the gradual fading of the aforementioned adverse factors, or for genuinely business-friendly policies (such as tax cuts, deregulation, and interest rate cuts) to be implemented, injecting new momentum into the economy. However, before these changes occur, we tend to hold a more cautious attitude towards the U.S. economic outlook.

Chart 1: February NAHB Housing Market Index Decline

Source: Wind, CICC Research Department

Chart 2: University of Michigan Consumer Confidence Index Hits New Low in Over a Year

Source: Wind, CEIC, CICC Research Department

Chart 3: February Services PMI Below the Growth Line for the First Time in Two Years

Source: S&P, Wind, CICC Research Department

Chart 4: U.S. Trade Policy Uncertainty Index Soars

![](https://mmbiz-qpic.wscn.net/sz_mmbiz_png/fzHRVN3sYs8NkHtyhwBbO5VCu6IhicXMAOVZfm8F7UZQUKcjfBYYUauLqZLkapc32rtiaUrPeKOkhib8uvlC2o8Og/640?Data source: EPU, China International Capital Corporation Research Department

Chart 5: The turnover rate after the implementation of the "buyout plan" is far higher than normal

Data source: Wind, China International Capital Corporation Research Department

Chart 6: Federal government "improper payments" exceed $200 billion

Data source: GAO, China International Capital Corporation Research Department

Chart 7: Mortgage rates remain high

Data source: Wind, China International Capital Corporation Research Department

Chart 8: New home inventory has increased

Data source: Haver, China International Capital Corporation Research Department

Authors of this article: Xiao Jiewen, Lin Yuxin, etc., source: [CICC Insights](https://mp.weixin.qq.com/s?__biz=MzI3MDMzMjg0MA==&mid=2247771522&idx=1&sn=0a699f0fbadc77a5c2c53346d4071a1a&chksm=eb4ff24a3126238019ec285e2cfa8efa5b12e5452c544caf41abdf202c6eaa2433bdc19a239c&mpshare=1&scene=23&srcid=0226lw0KEmFe786wrzp2ryp6&sharer_shareinfo=3f8d818453c949aee7e73b9edec9cad9&sharer_shareinfo_first=3f8d818453c949aee7e73b9edec9cad9#rd), Original title: "CICC: Focus on the Downside Risks of the U.S. Economy"

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