Brad Rogoff: Welcome to another episode of The Flip Side. I'm Brad Rogoff, Global Head of Research. And joining me today is Ajay Rajadhyaksha, our Chairman of Research. Welcome, Ajay.

Today's topic was one of the easier ones to come up with, because there's really one big macro issue going on right now. And to me, that is the US heading for a recession this year. And before you start to answer that, Ajay, I should say that today is April 10th or I guess, I should say, the first day of the 90-day pause on tariffs, just in case the market moves a little bit by the time people listen to this one.

Ajay Rajadhyaksha: Yeah, you're absolutely right, Brad. When we started discussing this, this wasn't as urgent an issue. But honestly, once the stock market started falling quickly, this is virtually the only question I get in every conversation.

Brad Rogoff: So how do you answer that?

Ajay Rajadhyaksha: In the affirmative, unfortunately.

Brad Rogoff: Okay. That's quite the dramatic change from a US economy that was growing, you know, about 2.5% last year. An outright recession after growing so strongly just three months ago. I mean, it's April now. It's pretty pessimistic. So growth is clearly slowing down. I'm not going to argue with that. And of course, there are recession scenarios.

But I think we need to question if we get all the way there. There's a temptation to jump right to tariffs when we do that, because that's a big part of your thesis I'm sure, and most people's thesis. But I'd like it if we could go a little bit more step by step. And if you think about the immigration side, you know, that's probably the easiest part to start with this forecast of a slowdown. So let's talk about that first.

Ajay Rajadhyaksha: Absolutely right. So you're right. The economy added about 2 to 2.5 million workers every year from 2022 to '24. Virtually all of that was due to immigration. Much of it was illegal or temporary humanitarian programs. And now it's almost completely shut off.

Brad Rogoff: And if you take that point, right, jobs created in the US depend on both demand for workers, but also supply of workers. So I can see why fewer jobs will be created because of this supply shock. But Ajay, most of these jobs are in low productivity sectors such as food services, constructions, etc.. The GDP hit therefore should be relatively small.

Ajay Rajadhyaksha: The GDP hit is relatively small for how large a supply shock this is, but it still adds up. And don't forget, Brad. Immigration and Customs Enforcement has been conducting regular sweeps across the country, so it's having a shadow effect. Undocumented workers who usually show up at hardware store parking lots, construction job sites, they've all been absent. And that's another related immigration hit to economic activity.

So look, we are penciling in a 35 to 50 basis point hit to GDP as the total drag from immigration policies changing.

Brad Rogoff: Fair enough. There's going to be a hit there. I'm not going to disagree with that. But if we look at what you just said and even take the higher end of that, that's an economy that was growing at 2.5%, maybe it could still grow at 2%. I get there's a lot else going on, but just, you know, let's go incremental here.

So now let's talk about the downside from the global trade war. And if your recession forecast is going to come to fruition, we got to talk numbers about that.

The average tariff on US imports, if we go back to the beginning of this year, was around 2%. And then all of a sudden as of April 2nd hit or after April 2nd, I guess I should say, jumped to 25%. And I realize it's actually still around 25% since even though we've rolled back to 10% for most of the world, excluding some areas like autos and metals, where we have 25% and potentially some pharma to come. We still have China at 125%, if not more. So take me through that math.

Ajay Rajadhyaksha: So you're absolutely right. The 125% is the Chinese reciprocal tariff. So remember we also put 20% on them for fentanyl, 10% in 2018 that were never rolled back. And the math is that when we have the average tariff at 25% for all US imports, roughly. Well, last year we imported about $3.2 trillion, $3.3 trillion of goods, about 11% of GDP. So at full implementation, you are looking at tariffs going up 22%, 23% on 11% of GDP.

Brad Rogoff: So that's helpful math. But the way I see it historically, let's say 50%, 60% of the increase in price due to tariffs is passed on to consumers. So companies, both importers and exporters usually absorb much of the remaining hit. And typically the currency of the tariff country weakens and also absorbs some of the blow.

Ajay Rajadhyaksha: That is correct. In fact, Secretary Bessent has publicly said he's counting on currency weakness from other countries as an offset to the tariffs. But look, this time so far, the US dollar has not rallied even after large tariffs were announced, which is a bit of a problem because it means one large shock absorber is missing. But say you are right, say history holds true, Brad. And 50%, 60% of the tariffs are what is passed on to the US consumer.

Brad Rogoff: And if that happens, I guess we have to assume that inflation goes up roughly 4%. But here's the thing. It's a one-time change in the price level. That should be it, or I guess we can never rule out future tariffs. But let's assume soon they're not coming yet. Next year, if those future tariffs don't actually occur, inflation by definition should come down pretty sharply.

Ajay Rajadhyaksha: Absolutely. But right now, Brad, I'll tell you, I'm worried about a recession in 2025 if inflation goes up to, say, 4% to 4.5%, and I agree that is a reasonable number. But if that happens, consumer spending in real terms pulls back by a similar amount. If inflation is 1.5 points higher due to tariffs, consumption is down 1.5 points. And that's 70% of the economy, that pulls down growth by, say, 1% just as a first order effect.

Brad Rogoff: All right. Let's stay on first order effects. You know, we can go to second order effects in a minute here. I'm not conceding totally on this point. I agree on the focus on consumption, 70% of the economy. We can't not focus on it. But inflation ran at 8%, 9% at some point in just 2022. And yet I don't remember the US consumer really pulling back. Do you?

Ajay Rajadhyaksha: No. But we were just coming out of two years of rolling lockdowns, Brad. A lot of us had not taken vacations, gone to restaurants for what seemed like a lifetime. Life was just coming back to normal. So there was a lot of pent up demand. In fact, that pent up demand, along with supply chain issues, was what pushed up inflation in 2022. A sudden catch up in all the things that we had been missing since COVID. But that's not the case now.

And also, in both '22 and '23, consumers in the US had massive amounts of excess savings. Governments wrote large checks from 2020, and your credit card bill went down in both '20 and '21. So sure enough, that's why you as a consumer kept spending in 2022 and '23.

Brad Rogoff: Well, in theory, we might not have the same amount of pent up demand anymore. But I got to tell you, if the markets keep doing this, maybe that's part of the ploy is to convince people that they need more vacations and actually to spend money. But on a more serious note, going back to the excess savings, yes, there's far fewer of them right now, but we still think there's some left by the calculations that our team does. And the unemployment rate remains very low by historical standards.

And don't forget, there's also a massive wealth effect. It's hard to remember with some of the gyrations obviously we've seen in the markets recently, but household wealth is up close to $50 trillion since the start of COVID, even considering some of the sell off that we've seen recently, and that's both homes and equities that have gone up so much. So when US households feel richer, they do keep spending. Or maybe in this case, when they feel rich.

Ajay Rajadhyaksha: Again, I'll concede the point that has historically been true. But that's where my second order argument comes in. Because you've had excess savings, because there's been this large amount of wealth created, the savings rate for US households is extremely low for the last three years. But consumer confidence has been collapsing now for the last three months after a steady drumbeat of government job cuts, fears of rising prices, policy uncertainty, actual tariffs. And now stocks falling.

If the savings rate goes up 2%, for example, from where we are right now, Brad, it would still be below 2019 levels when unemployment was lower than it is now. But if savings rise 2%, consumption falls 2%. That is another 1.5% hit to growth as a second order effect.

Brad Rogoff: Personally, I think you're overstating this a bit, Ajay. Consumer confidence should have taken a large hit across 2022, when stocks and bonds both had massive negative years and inflation also rose sharply. So to me, the death of the US consumer has been greatly exaggerated many times before.

I mean, we started this when you were talking about the question you get in meetings today. Questions about the health of the US consumer is a question that both of us have gotten in meetings for years and years and years. And it's maintained its health, generally speaking.

But let's change a little bit here. Let's go to the labor market, because that's my other argument. I already made the point that the jobless rate is still very low by historical standards. We just created 225,000 jobs last month. Initial jobless claims are tallied every week and those are really low too. The labor market seems just fine to me. So it's hard to see a recession under such circumstances.

Ajay Rajadhyaksha: Here's the thing. The jobs market is often a lagging indicator. You and I were both here on this trading floor, Brad, in October 2008, and we knew that the world had ended. It certainly felt like it. And yet the unemployment rate was still 6.1%. 13 months later, in late 2009, when the recovery was far under way, it stopped rising at 10%.

And look, 4.1% is a low jobless rate, yes, but it's also 70 basis points higher than the lows last year. And we think it goes up another 60 basis points. That will mean some job losses.

Brad Rogoff: So far we focused really on both sides of the consumer here. But what about the business sector? The government is focused on deregulating the economy. Small business confidence rose once we had the change in administration. Animal spirits. That's usually a way to help the economy, right?

Ajay Rajadhyaksha: That's fair. But in the last month, business confidence, I would say has been severely dented by the actual tariffs. And look, don't forget the size of the tariffs is so large in some cases that a bunch of countries, all trade should just completely stop.

Brad Rogoff: Look, the numbers that you referenced earlier, whether it's 125% on China, plus some of the other tariffs you can stack on top of that. Then what China's come back at the US with. I mean, the numbers are certainly cartoonishly high. I mean, probably to the point that basically all trade on both sides collapses.

Ajay Rajadhyaksha: Yeah, that's exactly my worry. So we're talking about 400 billion in exports from the Chinese to the US, roughly another 200 billion back from the US. And these are, like you said, large numbers. And they just screeched to a halt. Very few businesses can afford to import when your costs went up more than double overnight.

So if this continues for even a few weeks, I think you're looking at small and medium businesses in particular, failing and bankruptcies across a swath of industries in both countries.

Brad Rogoff: Okay, but that's a big if. I agree that this level of tariffs on each side doesn't work permanently. Let me take as an example what China's been doing with respect to US agricultural products. I mean, our farmers are going to struggle and Congress is going to have to pass new versions of bailouts if that's the case. But that's precisely why I don't think these tariffs will last. It's basically mutually assured destruction. And the President keeps saying he wants to make deals. You know, I think these tariffs on both sides will be softened at some point in the near future.

I mean, just this week, Ajay, the President announced a 90-day new moratorium on tariffs against everyone but China, with the exception of the 10%, to be fair. And you and I may have not have come up with a reciprocal tariff formula that has to do with deficits and not tariffs, like was the case here. But in advantage of these large tariff rates is that hopefully a lot of them can be negotiated down pretty quickly.

Ajay Rajadhyaksha: Well, I hope you're right. But even after the pause - and yes, the pause was welcome. I admit I'm cheered by that. On Wednesday - we are recording this on a Thursday. On Wednesday, market switched, absolutely. But even with that, the trade war has gone on for much longer and become worse than I ever expected.

We still have 10% reciprocal tariffs in place. We still have auto, aluminum, steel tariffs in place. There's still pharma more to come. Plus, deals may or may not happen in the next 90 days. But what will happen is businesses will remain uncertain.

Brad Rogoff: All right. I'm not really turning you into a glass half full guy but let me keep trying. You know, what about tax cuts, right? Maybe that can bring a smile to your face. The Senate's now considering a proposal to make the expiring tax cuts permanent, and the President wants more than just extension. He wants large new tax cuts. Not only should that help us avoid a recession, but would it even make you a little bit optimistic?

Ajay Rajadhyaksha: Well, look, I'm not holding my breath. I realize that the House passed the budget resolution that the Senate had put forward. So it does make the President's tax cuts that are expiring permanent. But there's no large new tax cuts there, Brad. And there's a bunch of spending cuts that Congress will have to agree on.

Remember, the budget resolution is just the first step. Then you have to write the bill, and then you have to pass it through the reconciliation process. If that happens, when that happens, yes, I'll breathe a little easier. But for right now, not a whole lot has yet happened.

Brad Rogoff: Well, normally at the end of this, I might say I look forward to seeing how this plays out. But I mean, large chunks of this may have changed quite a bit by the time you're actually listening to it. I can't argue with you that global growth is going to be lower than last year, but since a lot of the pain is self-inflicted, it can also change quickly and change positively quickly.

For now, though, clients can read our latest views in our most recent Global Outlook titled At a Crossroads, and visit the Tariff 2.0 Hub on Barclays Live.