January 2025: A Strong Economy (unfortunately with early cracks showing)

Entering January 2025, the new administration seems to have inherited a relatively healthy economy. The unemployment rate fell from 4.1% in December to 4.0% in January, dipping slightly below the commonly cited estimates of the natural rate (around 4.25%), potentially signals a labor market with limited slack, an indication that the economy is operating close to and potentially above its productive capacity. It would be too early to characterize the labor market as “tight” however, as the job opening to unemployment ratio is 1.13, a ratio that signals a broadly balanced labor market, albeit one in which labor demand continues to marginally exceed available supply.

While consumers continue to benefit from favorable employment conditions, however, inflation remains relatively elevated, limiting the extent to which these gains translate into improved purchasing power. Headline inflation increased from 2.9% to 3.0%, still stubbornly above the Federal Reserve’s 2% target. More importantly, core inflation matched this 0.1% increase (from 3.2% to 3.3%), suggesting that increasing demand is potentially to blame for the inflationary pressures rather than temporary supply-side shocks, resulting in “demand pull” inflation, a claim that aligns with the lower-than-natural unemployment rates observed. The strength of aggregate demand further reinforces this. Personal consumption expenditures increased by 0.4% in January, with nominal consumption growth outpacing headline inflation, implying positive real consumption growth. So far, the economy provides a clear signal that it is healthy and experiencing demand driven growth.

Additionally, as expected, inflation expectations remain well anchored. One-year-ahead inflation expectations held steady at 3% in January, showing no upward drift despite rising prices. This is promising, because as long as households do not internalize higher inflation into their future outlook, the risk of a self reinforcing inflation spiral remains contained.

The only slightly concerning indicator in January is consumer sentiment, which shows early signs of caution. The Consumer Confidence Index slipped from 74.0 in December to 71.7. While the decline is modest and far from signaling a collapse in confidence, it may reflect growing uncertainty, which is natural considering the new administration’s immigration and trade policies. 

Overall, January’s data paint a picture of an economy that is performing very well. Strong consumption, low unemployment, and rising core inflation suggest activity above potential, though not yet at a point of severe overheating, as the labor market is not yet “tight” and inflation remains within a manageable range. With inflation expectations anchored and confidence still relatively high, the economy appears responsive to policy intervention, meaning that policymakers can begin to consider the use of demand-management policies to mitigate inflationary pressures and possibly slow down demand growth before the economy overheats.

Ultimately, it can be said with no reservation that the Trump administration has assumed office amid an economy that, by most indicators, appears healthy. The challenge ahead will be whether this strength is preserved, considering how aggressive trade rhetoric will begin to weigh on business and consumer confidence.