What Could Derail the Economy This Year?

To help you understand what is going on in the economy and beyond, our highly experienced Kiplinger Letter team will keep you abreast of the latest developments and forecasts (Get a free issue of The Kiplinger Letter or subscribe). You'll get all the latest news first by subscribing, but we publish many (but not all) of our forecasts a few days afterward online. Here’s the latest...

This should be a decent year for the economy, with GDP growing faster than its long-term average, unemployment staying relatively low, and consumers continuing to spend at a modestly robust pace. But it pays to consider what may go wrong, and think about how it would impact your situation. Here are the biggest risks we can foresee to the economy in 2025, and how realistic they are.

1. Bond Yields
The most obvious worry is rising bond yields. The yield on the key 10-year Treasury note is up by more than a percentage point since September when the Federal Reserve first cut short-term rates. Expectations for strong growth, higher inflation and larger budget deficits are clearly on the minds of bond investors. The trillion-dollar question now: How much more could yields rise? Is this a short-term increase, or are we in the midst of an extended bear market in bonds — one driven by inflation that stays stubbornly elevated? The latter could push bond yields to levels that sap growth. We look for at least a small further gain. That shouldn’t derail the economy. It’ll hurt, especially for the housing market, where affordability is already smothering sales, but GDP growth should be able to withstand higher, but historically normal, yields. A spike well above 5% on the 10-year yield would be a different matter. Many borrowers would struggle, not least the Treasury, given its flood of red ink.

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2. Inflation
Related to yields, inflation could prove stickier than the Fed hopes. Tariffs have the potential to boost inflation if they’re levied broadly by the new administration, which could force the Fed to cancel plans to trim interest rates, or even hike them. Also, if U.S. tariffs on imported goods lead to retaliation by some of our trade partners. An outright trade war could both spur inflation and hobble the economy. We don’t expect one, and think President-elect Trump will mostly threaten to levy tariffs to gain negotiating leverage in talks on a variety of issues. But, it can’t be ruled out.

3. Other risks
Some of these are certain to occur but unpredictable, some are merely possible: Natural disasters. The horrific California fires are a grim reminder of the damage that Mother Nature can wreak, to life and property. More disasters this year are a given, but the question is how many and how severe.
A stock market drop. We don’t see one coming, but it’s only a matter of time before the sharp rally since 2022 hits some sort of correction. Pullbacks are healthy if they cool speculative mania. Nasty bear markets can sap consumer confidence and spending, crimping economic growth. Tech stocks in particular look overbought.
Geopolitical risks. A flare-up of ongoing wars or the start of a new one. These are unpredictable, but there’s little doubt the world has grown more dangerous.

This forecast first appeared in The Kiplinger Letter, which has been running since 1923 and is a collection of concise weekly forecasts on business and economic trends, as well as what to expect from Washington, to help you understand what’s coming up to make the most of your investments and your money. Subscribe to The Kiplinger Letter.

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