Trump's tariffs will hit the U.S. economy hardest in the near term

The Trump administration’s tariffs—combined with any retaliatory measures from U.S. trading partners—will, if implemented, deliver a supply shock to the U.S. and a demand shock for the rest of the world. The severity of these shocks will depend on the outcome of ongoing trade negotiations and legal challenges. However, it seems certain that the world’s two largest economies, China and the U.S., will experience lower economic growth than projected at the beginning of the year—and the ramifications of this will be felt across the globe irrespective of any individual trade deals struck.

The U.S. faces downside risks to the growth outlook even as higher reciprocal tariffs with China and other trading partners have been paused. Businesses face rising input costs, which would squeeze profit margins and force some firms to reduce investment spending. Tariffs on consumer goods will likely reduce real purchasing power and slow consumer spending, which accounts for more than 70% of U.S. gross domestic product. Any further downward pressure on the U.S. dollar could exacerbate upside risks to inflation.

The U.S. labor market has remained resilient so far, but recent data confirm that it has transitioned from exceptionally tight in 2022–2023 to more balanced now. This implies a thinner cushion for the labor market than at any point in the post‑pandemic period. In the event of a large and persistent shock to economic activity, a pickup in the pace of layoffs would push up the unemployment rate.

The U.S. Federal Reserve (Fed) is in a difficult position as it balances the risk of tariff‑fueled inflation with supporting a weakening economy. This tension will likely linger through 2025. President Donald Trump has been leaning heavily on the Fed to cut rates, but the Fed’s independence remains intact for now. For the remainder of the year, we expect the focus to be on deregulation and fiscal measures such as tax cuts, which could deliver a boost for U.S. growth. We will monitor these developments closely as they would pose upside risks to both the growth and inflation outlooks.

China’s more focused trade war gives it more options

As the main target for U.S. tariffs, China also faces economic headwinds in the second half of the year, albeit different in nature and probably less severe than those the U.S. faces. Although negotiations between the two countries have resulted in lower tariffs, those currently in place will still have a major impact on U.S.‑China trade.

One advantage China has is that while the U.S. is busy fighting a trade war with almost every country in the world, it is only fighting one against the U.S. As such, China will likely seek to reship many of its goods through other countries with lower tariffs. If this happens at scale, it will mitigate the growth and deflationary pressures China faces, although it may not be enough to prevent a growth slowdown. We expect Beijing to use a combination of monetary and fiscal stimulus to offset the drag on growth from tariffs, but any such measures will be taken sequentially and in response to data rather than being rolled out all at once.

No region unaffected by battle of the heavyweights

Despite being lowered from the levels previously threatened, the U.S.’s tariffs on China will still impact the eurozone in several ways: First, because weaker growth will reduce China’s demand for European exports; second, because Chinese manufacturers seeking to redirect their exports away from the U.S. will provide more intense competition for European exporters in other markets; and third, because a surge of Chinese imports will contribute to goods disinflation within the eurozone itself.

Combined with the direct impact of the eurozone’s own trade tensions with the U.S., these secondary impacts from China will likely contribute to slowing growth in Europe in the second half of the year. Inflation should continue to decline in the near term, and while Germany’s debt brake reform will eventually provide a boost to the eurozone economy, this may take some time to materialize. Negotiated wage growth in the eurozone is expected to continue falling, giving the European Central Bank further latitude to cut rates—and we expect it to do so several times before inflation risks rise again in 2026.

Deflationary pressure in China is also likely to spill over into other emerging markets (EMs) as Chinese goods are redirected to other countries in the region, lowering prices. Weaker global growth and lower commodity prices may bring further disinflationary pressures in EMs, with commodity producers likely to remain under pressure. Given the uncertainty, most EM central banks will be cautious and wait for the data to tell them what to do next—although the weaker U.S. dollar will give some of them more room to cut rates without risking a currency sell‑off or inflation spike.

Global economy buffeted from multiple directions

(Fig. 1) Fiscal reform and deregulation could partially offset tariff impact

As of May 31, 2025.
For illustrative purposes only. Actual future outcomes may differ materially from forward-looking statements.
Source: T. Rowe Price.

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Key takeaway

The world’s two largest economies will be most affected by tariffs, with inevitable consequences for all other regions.