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The U.S. economy is all over the place right now. Rapidly evolving trade policy has everyone — consumers, corporate America and the rest of the world — navigating a period of major uncertainty.

And underlying all of it are two big questions: Is a recession coming, and how does all the talk about a recession influence whether we have one?

Let’s start with what a recession means. Economists say the odds of a recession are higher as the president imposes tariffs on most of America’s trading partners. But the definition of a recession is different depending on who you ask.

If you took Economics 101, your professor likely told you the most popular rule of thumb: A recession is two consecutive calendar quarters of declining growth in the nation’s gross domestic product (the value of all goods and services produced).

There’s also the relatively new Sahm Rule, which relies on changes in unemployment rates to detect a recession, and the inverted yield curve indicator, which looks at how investors feel about U.S. Treasury securities. (Here’s the nitty gritty on when each of these indicates a recession if you want to dive deeper.)

But the National Bureau of Economic Research, a nonpartisan, nonprofit research group in Cambridge, Mass., is the official arbiter of whether the U.S. economy is in a recession, and that group defines it as a “significant decline in economic activity that is spread across the economy and lasts more than a few months.”

NBER economists say they have no fixed rule about the metrics they use to assess recession periods, though they consider more than GDP. They’re also willing to stray from their standard definition — as they did during the early days of the pandemic — when the downturn in March and April of 2020 was deep enough to qualify despite lasting only two months.

So where are we now?

U.S. GDP shrank for the first time in three years in the first quarter, but mainly because companies that were stocking up on goods ahead of pending tariffs triggered a sharp increase in imports (which are subtracted when calculating GDP.)

Some economists said the first-quarter decline belied a more positive underlying strength, and GDPNow,
which follows various economic indicators in real-time, shows GDP is on track to grow again in the second quarter.

Of course, fast-moving trade policy makes it especially hard to predict what’s ahead, and that gets at the bigger takeaway here.

The government’s temporary truce with China this week had multiple economists revisiting their forecasts.

One at Apollo Global Management who had recently predicted a near certain 2025 recession if trade policy didn’t change said the China news lowered the odds to 30%.

Another at J.P. Morgan reportedly said the chances had fallen to below 50% from 60%. And it’s worth noting that the probability of a recession in any given year is about 15%, according to Oxford Economics.

So what? A recession is one thing, but what may matter more is how we all feel about the future.

Already, the economy is churning out a mixed bag of numbers. Consumer spending and employment levels are holding relatively strong, but surveys show Americans are much more pessimistic about their current and future financial situation. One benchmark of consumer expectations has fallen to a 13-year low.

Meanwhile, the S&P 500 Index briefly dipped into bear market territory in April, and companies are lowering earnings expectations and cutting back on orders.

Last month the CEO of Southwest Airlines told Bloomberg domestic leisure travel has dropped more than he’s ever seen outside of the pandemic.

“I don’t care if you call it a recession or not, in this industry that’s a recession,” he said.

Related Reading

•   5 Things to Do If You’re Worried About a Recession (SoFi)

•   U.S. Recessions Throughout History: Causes and Effects (Investopedia)

•   Tariffs Will Be Bad, but They Won’t Cause a Recession (Manhattan Institute)

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Gentle Dip

April’s inflation data offered a welcome downside surprise, with the Consumer Price Index rising less than investors had expected in April: 0.2% instead of 0.3%. That puts the year-over-year rate at 2.3%, the lowest since February 2021, when the economy was just beginning to grapple with the initial wave of pandemic-related price surges.

Drivers of the cooler rate were mixed. Housing costs remain a primary contributor, while increases in natural gas and electricity costs also added to the overall inflation rate. On the other hand, food prices declined 0.1% (the first overall decline since July 2020), with egg prices plunging a whopping 12.7%.

All in all, recent data suggests a disinflationary trend through April. This is especially evident if you look at the seasonally unadjusted data. After a brief spike at the start of the year, actual price increases have been below what we’ve seen in recent years and in-line with pre-pandemic levels.

Consumer Price Index M/M % Change (Not Seasonally Adjusted)

For investors, a return to a more predictable and lower inflation environment would typically imply lower interest rates and calmer market conditions — and potentially higher P/E multiples as a result. But tariffs could still disrupt the optimistic disinflationary trends in the data. While the recent detente between the U.S. and China has boosted investor sentiment, trade policy uncertainty lingers.

That uncertainty can act as a significant drag on economic activity. Businesses faced with unpredictability regarding future input costs, supply chain stability, or access to international markets may slow their capital expenditure and hiring plans. That, in turn, can dampen overall economic growth.

The Fed’s Next Move

At the beginning of Trump’s second term, market pricing pointed towards one or two interest rate cuts by the Federal Reserve in 2025.

As trade upheaval intensified in March and April, however, recession fears rose. Investors began to anticipate that the Fed would act to support the economy, despite the risk of inflation shocks. Since then, expectations for cuts have eased with year-end expectations now near where they were before all the turmoil.

Market-implied Rate Cuts

Nevertheless, tariffs remain a major wildcard in the Fed’s policy deliberations. As things currently stand, they’re paused, not fully ruled out. And because the tariffs pull at the Fed’s dual mandate of price stability and maximum employment, that could lead to higher inflation and higher unemployment.

That leaves the Fed caught between a rock and a hard place – lower interest rates to protect the labor market and inflation may spiral higher, keep rates high to fight inflation and the economy could weaken significantly. The ongoing disinflationary process could be disrupted down the road if additional tariffs take effect.

If that weren’t enough, the Fed’s emphasis on being data dependent means that it is unlikely to act if the economy’s trajectory is unclear. And without a resolution on the trade front, it’s hard to get clarity. This all suggests that the Fed could adopt a more cautious “wait-and-see” approach. Current market pricing indicates a 97% chance of a rate cut by September, but the 90-day pauses on tariff implementation means that could move around a bit.

Shape of the Curve

Trade policy has been the main focus of investors over the last few months. That is likely to continue, but interest rate policy is a contender for second place. In what is sure to be a volatile period for interest rates, focusing on the Treasury yield curve could offer valuable insights for investors – even for those that invest primarily in stocks.

The last week or two has mostly consisted of what is called bear flattening, an environment where Treasury yields rise, with shorter-term yields rising more quickly than longer-term maturities. This dynamic emerged as the market priced out the possibility of interest rate cuts. Such environments often correspond with mixed, but generally positive, stock market returns, as we’ve seen this month.

But forward returns depend on how the future evolves. If we had a crystal ball and knew what the yield curve would do, it would be easier to invest. Alas, we don’t, but that doesn’t mean we can’t come up with some ideas.

If the economy remains resilient and tariff fears ease further, we could see bear flattening continue as rate cuts get priced out further. Maybe instead of two rate cuts this year, the Fed doesn’t cut at all. Sector performance during bear flattening phases tends to be quite varied, without a single, consistently dominant theme.

On the other hand, if the economy weakens we could see Treasury yields fall (in other words, a “bull” move for bonds). When Treasury yields are falling (a “bull” market for bonds), the implications for stocks depend significantly on how the yield curve’s shape changes. The two main possibilities here are bull flattening and bull steepening.

Scenario 1: Bull Flattening (Long-term yields fall faster than short-term yields)

•   This move is often driven by expectations of lower long-term inflation, a flight to the safety of longer-dated bonds amid economic uncertainty, or expectations that slower economic growth in the future will allow the Fed to eventually lower interest rates.

•   This environment is usually pretty positive for stocks and typically occurs more often during late-cycle environments. It has historically favored sectors that are more sensitive to changes in long-term interest rates like Real Estate, Utilities, and Technology.

Scenario 2: Bull Steepening (Short-term yields fall faster than long-term yields)

•   This move typically happens when the market expects the Fed to lower interest rate cuts in order to stimulate an economy that is either weakening or is in recession.

•   While interest rate cuts are usually beneficial for stocks, the economic conditions that need to be present for the Fed to lower interest rates meaningfully are usually negative for stocks. Defensive sectors such as Utilities, Consumer Staples, Health Care, and Real Estate have historically outperformed the broader market in these environments.

Relative Monthly Returns for Sectors vs. the S&P 500 When Treasury Yields Decline

Bull flattening periods usually come before bull steepenings – an economy usually decelerates before it falls into recession – but it can be hard to pinpoint the transition point. Investors may cheer for lower interest rates, but any potential gains can quickly reverse if a significant economic slump gets priced in.

In those moments, a more defensive portfolio posture would help partially insulate against stock market declines. That might be worth considering given lingering trade uncertainty, but as the saying goes: There’s no such thing as a free lunch. A favorable resolution on the trade front with no major economic slowing could boost cyclicals.

Investing isn’t always easy, but it’s worth it in the long run. Stay diversified and stick with it.

Want more insights from SoFi’s Investment Strategy team? The Important Part: Investing With Liz Thomas, a podcast from SoFi, takes listeners through today’s top-of-mind themes in investing and breaks them down into digestible and actionable pieces.

SoFi can’t guarantee future financial performance, and past performance is no indication of future success. This information isn’t financial advice. Investment decisions should be based on specific financial needs, goals and risk appetite.

Communication of SoFi Wealth LLC an SEC Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at www.adviserinfo.sec.gov. Mario Ismailanji is a Registered Representative of SoFi Securities and Investment Advisor Representative of SoFi Wealth. Form ADV 2A is available at www.sofi.com/legal/adv.