A series of policy proposals by Trump has cast a thick fog over the U.S. economy. Morgan Stanley believes that next year, the global market may face a U.S. economy characterized by slowing growth and more stubborn inflation.
In a recent forward-looking report, the team of Morgan Stanley economist Seth B Carpenter warned that if Trump fulfills his promises to tighten immigration policies and raise tariffs, the U.S. labor market and trade will be impacted, putting pressure on U.S. GDP growth over the next two years and making the path to lower inflation more difficult.
Considering the initial inflationary pressures and the uncertainties surrounding Trump's policies, Morgan Stanley expects that the Federal Reserve will remain cautious about the future interest rate path and will begin to pause interest rate cuts in the second quarter of next year. As economic growth slows, employment growth is expected to nearly stagnate in the second half of 2026, at which point the Federal Reserve is expected to restart interest rate cuts.
<h2>Economic Pressure Mounts</h2>
Given the significant pressure on the economy from stricter immigration policies and high tariffs, Morgan Stanley forecasts that U.S. GDP growth will slow from 2.4% in 2024 to 1.9% in 2025, and further decline to 1.3% in 2026.
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Morgan Stanley believes that the new government's expulsion and exclusion of illegal immigrants will lead to a decrease in net immigration from 3.3 million in 2023 to 500,000 in 2026. The reduction in immigration is expected to keep the labor market tight in 2025, but as economic growth falls below potential, the unemployment rate will rise in 2026.
According to Morgan Stanley's estimates, the unemployment rate will be 4.3% by the end of 2024, 4.1% in 2025, and 4.5% in 2026. The decrease in immigration means a significant drop in employment numbers in 2025 and 2026.
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Although the consumer base remains solid, consumption growth is expected to slow significantly in 2025 and 2026 due to factors such as a cooling labor market, rising tariffs, and reduced immigration.
Morgan Stanley expects real consumption growth to be 2.6% in 2024, dropping to 2.0% in 2025, and 1.3% in 2026. The decline in goods consumption is smaller compared to services consumption, as lower interest rates support durable goods consumption.
In terms of fiscal policy, Morgan Stanley believes that the momentum of fiscal spending in 2025 will weaken. Although the new government will implement tax legislation, it will mainly maintain existing tax reduction policies rather than stimulate economic growth.
<h2>Business Investment to Maintain Steady Growth Next Year, AI Investment May Contribute More to GDP</h2>
In recent years, business investment has been limited to specific industries, such as the manufacturing investment boom in 2023 and the AI investment wave in 2024
In particular, AI-related investments have significantly accelerated over the past year, and Morgan Stanley expects this trend to continue in 2025 and 2026. The growth of AI investments is expected to positively impact investments in data centers, power infrastructure, and related technological equipment, directly contributing to GDP growth.
Morgan Stanley forecasts that real business fixed investment will grow by 4.0% in 2024, 3.9% in 2025, and 3.2% in 2026; structural investment is expected to grow by 1.6% and 5.4% in the next two years (with half contributed by AI).
AI has already begun to drive investments in data warehouses and power-related structures. Morgan Stanley anticipates that investments in data warehouses and power-related sectors will further accelerate.
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We expect the strong performance of AI to contribute about half of the growth in structural investment in 2025. For 2026, we expect growth to slow to 4%.
Compared to 2025, the contribution of AI-related structural spending in 2026 is roughly the same (3.5 percentage points). However, adverse factors related to tariffs have reduced growth by three-quarters of a percentage point.
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Morgan Stanley expects that AI investments will raise U.S. GDP by 0.1 percentage points in 2024.
The report notes that at the beginning of 2023, there was an upward trend in investments in data center structures, and investments in power construction and computers also increased during 2023. These three types of business investments may indicate the effects of accelerated investment. Additional investments in power-related structures and data centers directly drove GDP growth. However, investments in AI-related equipment primarily rely on imports, with 75% of domestic computer spending going towards imports, and additional battery storage almost entirely dependent on imports. Therefore, the positive impact of current AI equipment spending on GDP is largely offset by imports.
It is expected that by 2025, AI investments will have a greater impact on economic growth, expected to increase by 0.25 percentage points. Spending on data warehouses and power structures will contribute 3.5 percentage points to structural investment and one-tenth to GDP. Despite rapid growth in imports, spending on computers and related equipment will also make a similar contribution.
By 2026, due to a slowdown in data center construction growth, the contribution of AI investments to GDP growth may drop to 0.15 percentage points.
<h2>Trade Under Pressure from High Import Tariffs</h2>
In the next two years, Trump's high import tariff policy is expected to put pressure on imports, while a slowdown in Mexico's growth and a strong dollar outlook are expected to lead to a slowdown in exports.
Morgan Stanley predicts that trade will have a slight drag on GDP growth in 2025 (-0.2 percentage points), but the impact will lessen in 2026 (-0.1 percentage points) as import growth slows.
Despite the pressure on imports from tariffs, the continued growth of AI investments is expected to support imports, especially in 2025 and 2026. Morgan Stanley states that U.S. companies will continue to seek dedicated hardware, advanced electronic devices, and other technological components for AI research, development, and infrastructure.
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<h2>More Stubborn Inflation</h2>
Morgan Stanley expects inflation to continue to slow down before the first quarter of 2025, but then become more stubborn.
Specifically, the core PCE inflation rate in the United States is expected to drop to 2.8% in 2024, but due to a tight labor market and high tariff policies, this figure will remain at higher levels of 2.5% and 2.4% in 2025 and 2026, still above the Federal Reserve's target level.
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Morgan Stanley believes that the impact of increased tariffs on inflation is expected to become more pronounced later in 2025, while the tight labor market may drive wage growth in 2025, putting pressure on service sector inflation.
<h2>More Cautious Rate Cut Path</h2>
With the pro-monetary easing Trump administration in power, inflation could be ignited inadvertently, and the Federal Reserve must be cautious about the future path of interest rates.
Morgan Stanley expects the Federal Reserve to continue cutting rates in the first half of 2025, with each cut of 25 basis points, until the federal funds rate reaches 3.625%. However, due to the tight labor market and pressure from service sector inflation, as well as residual seasonal factors, the Federal Reserve may pause rate cuts after May 2025. At the same time, the Federal Reserve will end quantitative tightening (QT) in the first quarter of next year.
Only when inflation stabilizes and begins to decline, and economic growth significantly slows due to tariffs, might the Federal Reserve resume rate cuts in the second half of 2026. Morgan Stanley expects the federal funds rate to drop to 2.375% by the end of 2026.
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Morgan Stanley has made assumptions about the outlook for U.S. interest rates in 2025:
<blockquote>
Scenario 1: U.S. Hard Landing – Neutral rate lower than expected, Federal Reserve over-tightens. Monetary policy lags, only beginning to affect the economy in the first quarter of 2025, leading to a sharp economic slowdown and inflation below target, resulting in a hard landing.
In this case, Morgan Stanley expects the Federal Reserve to rapidly cut rates to 1% in the first half of 2025 and maintain that until the second half of 2026. It forecasts GDP growth of -0.3% in 2025 (year-over-year quarterly) and 1.8% in 2026.
Scenario 2: U.S. Re-Acceleration – Economy rebounds in 2025 due to rate cuts. Neutral rate higher than expected, Federal Reserve cuts rates too much, leading to economic re-acceleration and rising inflation.
In this scenario, productivity growth is stronger, and the neutral rate remains high. Morgan Stanley expects that after the policy rate drops to 3.625%, the Federal Reserve will raise rates again in the fourth quarter of 2025, increasing the rate to 3.875% by the end of 2025, and further raising it to 4.875% by the end of 2026
The GDP growth is forecasted to be 2.8% in 2025 (year-on-year quarterly) and 2.3% in 2026
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Morgan Stanley believes that Trump's immigration and tariff policies will lead to a dual challenge of slowing economic growth and stubborn inflation in the U.S. next year: GDP growth is expected to slow to 1.9%, while core PCE inflation remains high at 2.5%. The Federal Reserve is cautious about the interest rate path and is expected to pause rate cuts starting in the second quarter of next year

- Morgan Stanley warns that Trump's policies may lead to a slowdown in U.S. economic growth and persistent inflation, projecting GDP growth to decline from 2.4% in 2024 to 1.9% in 2025 and 1.3% in 2026.  
- The firm anticipates that stricter immigration policies and high tariffs will tighten the labor market, resulting in rising unemployment rates and reduced consumer spending growth.  
- Despite these challenges, business investment, particularly in AI, is expected to contribute positively to GDP, although trade pressures from tariffs may hinder overall economic performance.

Morgan Stanley Outlook for the U.S. Economy in 2025: The Era of "High Inflation, Slow Growth" is Coming, and Interest Rate Cuts Enter the "Slow Lane"