Three Gray Rhinos of the U.S. Economy in the Second Half of the Year

The rapid passage of the OBBB Act has allowed Trump to leave a dazzling political achievement on July 4th, reflecting his stronger control over domestic affairs. After a relatively quiet month in foreign affairs, he may regain vitality and become more assertive, thus increasing the backlash risk of TACO. The more intense verbal sparring between the old and new Federal Reserve chairs may also trigger greater chaos.

Based on this, we believe there are three "gray rhino events" for the U.S. economy in the second half of 2025:

1) After the implementation of the Great Beautiful Act, fiscal policy will do more "subtraction," showing a clearer tendency for spending cuts;

2) External tariffs and the reshaping of international relations will become more "pragmatic and aggressive," increasing the backlash risk of TACO;

3) The differences in interest rate cut attitudes between the old and new Federal Reserve chairs will cause confusion, with the shadow Federal Reserve chair possibly holding "market dominance."

Predicting so-called "gray rhinos" and "black swans" is always difficult. More importantly, it is essential to think along the logic pivot of "refusing linear extrapolation": the path Trump takes to achieve his goals is dynamic, but the fundamental appeal (i.e., returning to America's golden age) is static; all chaos will revolve around this.

A thousand people have a thousand different "golden ages," but in Trump's eyes, the America of 1990, with its manufacturing boom, is likely "greater" than the present.

(1) After the implementation of the Great Beautiful Act, the incremental fiscal capacity in the U.S. will be limited, and future fiscal spending will do more subtraction.

It is almost certain that before the U.S. economy enters a recession, it will be challenging to see new fiscal stimulus policies. However, under the pressure of deficits, the demand for fiscal contraction will become increasingly urgent. The U.S. is likely to enter a phase of spending cuts: this includes both exploring new areas for spending cuts (DOGE 2.0) and making more "effective and proactive" efforts within the existing framework.

Especially in terms of spending cuts, we emphasize again that Trump does not view the OBBB Act as a political tool: in the reduction of SNAP benefits, he is even more aggressive towards traditional red states and swing states with higher political costs. (For more on the determination for spending cuts in the OBBB Act, see "A Different Perspective on the 'Great Beautiful Act'.")

The "legacy" of the DOGE 1.0 period is still shining, for example, the U.S. State Department is implementing a new round of layoffs and advancing the disposal of government assets; on the other hand, it is essential to recognize that Trump's split from Musk is not due to Musk's lack of effort in "spending cuts," as Trump has never denied the importance and significance of DOGE.

Another noteworthy point is that the OBBB Act is more about "tax cuts" rather than straightforward "transfer payments," which means that if the economy weakens and private sector taxable income declines, the stimulating effect of the act itself will be further discounted

The source of spending cuts is the undeniable deficit issue. For the United States, a deficit rate exceeding 6% during normal economic operations is akin to the sword of Damocles; any official lacking the will to cut spending can frequently look up to see if they are one step closer to it. Trump is not oblivious to this, nor is he unaware of the urgency of spending cuts.

(2) The risk of TACO backlash is increasing, and Trump is becoming more "radical and pragmatic" in reshaping tariffs and international relations: more "liberation days," more frequent "TACOs," and greater volatility.

Recently, Trump has focused on domestic affairs, appearing somewhat "silent" on the international stage. After the OBBB Act was passed in Congress on July 4, Trump's short-term "domestic troubles" have disappeared, and he will once again turn to issues related to tariffs, military protection fees, and other topics concerning the United States' medium- to long-term international competitiveness.

Trump has become more "radical and pragmatic" externally, which means that every non-American economy needs to rethink what negotiation chips they can offer: alliances or closer trade ties are merely tickets for quick participation in Liberation Day 2.0, but do not guarantee a good deal.

More importantly, demonstrating hard power is crucial, such as China's supply advantages in strategic resources like rare earths and metal minerals; it is especially noteworthy that the bargaining power of soft power is declining in this round of negotiations, such as the traditional "Western cultural ties" of the UK and EU, the "North American locational advantage" of Canada and Mexico, and the "geostrategic value" held by Southeast Asian countries and Japan and South Korea.

Japan and South Korea, the two most important American allies in Asia, are also key participants in Trump's efforts to curb China's influence and have been chosen as the first round of recipients of his outreach. The objective reality is that South Korea has taken the lead in aligning with the U.S., while Japan's stance is firm, which does not seem to hinder Trump from treating them equally.

The tariff structure concerning Vietnam is particularly noteworthy; this phased tariff targeting transshipment is experimental: exploring the feasibility of tiered measures, testing the acceptance of trading partner countries, and more importantly, observing China's response and specific countermeasures.

It can be expected that issues that have not appeared in the news for a long time, such as "TikTok acquisition," Greenland, the Panama Canal, and the "Gulf of Mexico," will gradually return and become negotiation chips on Trump's table.

While Trump acts as an international affairs intervener and tries to please voters, one point he seems to overlook is that: other countries also have politics, and the views of voters in these countries will constrain corresponding actions. Moreover, the political pressure within the United States cannot be ignored; if every important bill requires Trump's personal mediation to pass procedural votes, the U.S.'s large and complex political system will also become a stumbling block for Trump Based on this, we must once again emphasize the vulnerability of TACO. Trump's retreat is merely based on a "worst-case scenario" at a certain moment, which does not mean that economic damage has not occurred, and as time goes on, the baseline of this "worst-case scenario" will become lower.

(3) The remote confrontation between the new and old Federal Reserve Chairmen causes chaos, and the shadow Federal Reserve Chairman may hold "market pricing power."

As time progresses, the next Federal Reserve Chairman will gradually become clear. Powell will step down from the position of Federal Reserve Chairman in May 2026. Assuming he also resigns as a governor, at that time, we may see at least four out of seven Federal Reserve governors supporting Trump's monetary policy stance (Waller, Bowman, the successor to Quarles, and the successor to Powell).

One concerning point is that even if following tradition, a new chairman is normally nominated within the year, everyone will regard him/her as the "shadow Federal Reserve Chairman," amplifying the differences in monetary policy statements between the new and old Federal Reserve Chairmen. In the current climate where calls for Powell's dismissal are rampant, it has become very difficult to return to a normal succession rhythm.

Whether it is the shadow Federal Reserve Chairman or seizing Powell's monetary policy dominance in a more radical way, the impact on the United States is no less than Liberation Day 1.0, and may even be more severe. The selling pressure on long-term bonds may be magnified several times, and U.S. Treasury rates are the core pricing factor linked to different global markets. The triple whammy of stocks, bonds, and currencies in the U.S. is unavoidable, and continuous spillover effects need to be closely monitored.

In the near future, the Federal Reserve's actions are difficult to decouple from politics. Especially with the upcoming interest rate cut decisions that rely heavily on subjective judgment: this not only depends on the assessment of the economic situation but also on the randomness of Trump's tariff rhythm.

If not handled well, it is easy to share the blame with Trump (for example, not cutting interest rates leading to an economic recession, or unnecessary large rate cuts triggering re-inflation). Powell wants to avoid the continuation of these two scenarios for a soft landing, but the incoming chairman may not care; this naturally forms a stance confrontation between the new and old Federal Reserve Chairmen.

For Powell, the more independent and rebellious he is, the greater the political legacy he leaves behind; currently, he has no reason to yield to Trump's extreme pressure.

Another point is the "public desire for rate cuts," as both stocks and bonds will benefit from a looser monetary environment (even if this level of looseness is unnecessary); but when it comes time to raise rates, will Trump's current "Too High" be countered by "Too Low," thereby artificially increasing the volatility of monetary policy?

It is also worth noting that after resolving the debt ceiling this year, the TGA account needs to be replenished by about $500 billion, and the traditional approach is to finance with short-term debt; issuing short-term debt also means there will be greater demands for the Federal Reserve to cut rates.

Indeed, the Federal Reserve Chairman nominated by Trump may not necessarily act according to his wishes after taking office (Powell is an example), and this could become a replication of the current situation, with the continuation of such criticism further undermining the credibility of the dollar.

The new and old Federal Reserve Chairmen will continue to hold differing views on monetary policy, especially how the public statements of the incoming chairman will be interpreted by the market, and whether they will be priced in to a more dovish monetary policy path is worth noting.

In the short term, the overall path of interest rate cuts will not only be complicated by the still chaotic economic data; it will also become more elusive due to the remote confrontation between the new and old chairmen. From a medium-term perspective, fiscal dominance based on Trump's intentions may become a normalized disturbance during his term; when considering changes in monetary policy, "What does Trump want" will linger in the mind for a long time.

Authors of this article: Song Xuetao, Zhong Tian, Source: Xuetao Macro Notes, Original title: "Three Gray Rhinos of the U.S. Economy in the Second Half of the Year (Guojin Macro Zhong Tian)"

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