Why the U.S. Could Avoid a Recession in 2025: A Liquidity-Driven Perspective

For much of the past two years, markets and economists have flagged an impending U.S. recession. Yield curve inversions, tightening credit, and deteriorating sentiment painted a classic late-cycle picture. However, high-frequency and liquidity-based indicators now challenge that narrative. The U.S. economy powered by fiscal expansion, growing interest outlays, broad money supply revival, and easing financial conditions may be resilient enough to avoid contraction.

1. Divisia M4: The Monetary Aggregate That Matters

Traditional aggregates like M2 miss the full picture. Divisia M4, which includes shadow banking instruments (e.g., repos, institutional money market funds), shows a more complete view of liquidity. After collapsing into negative territory in 2023, Divisia M4 growth has now rebounded to +3.2% YoY (as of Mar 25). This rebound signals a re-expansion of broad, usable money, which underpins nominal demand, asset prices, and credit flows. Recessions are often liquidity events and right now, liquidity is building again.

2. Rising Interest Payments = Stimulus

With U.S. debt at record highs and interest rates elevated, federal interest payments are ballooning. But these are not just fiscal burdens they’re income transfers to the private sector. When the U.S. pays more interest on Treasuries, households, pension funds, and financial institutions receive that income, which then re-enters the economy via consumption or reinvestment. In essence, rising debt servicing costs are functioning like a stealth fiscal stimulus, especially when private demand is soft.

3. The Labor Market and Withholding Taxes Are Stabilizing

Withheld income and employment tax receipts a real-time proxy for labor income have rebounded notably from their mid-2024 slump, indicating that wage growth is holding up and employment remains resilient despite a cooling in job openings. The continued flow of household income is supporting consumption and helping to sustain overall demand. This recovery aligns with other nominal indicators and reinforces the view that the engine of income generation in the U.S. economy remains intact.

4. Financial Conditions Are Loosening, Not Tightening

One of the most underappreciated signals in the current macro environment is the loosening of financial conditions, as reflected in the National Financial Conditions Index (NFCI) a composite of risk, credit, and leverage metrics. Throughout late 2024 into early 2025, the index has trended well below zero, indicating a broadly accommodative backdrop. Leverage and credit conditions have eased, and risk appetite remains firm, supported by improving liquidity (as captured by Divisia M4), lower volatility, and tighter credit spreads. Institutional investors appear to be re-risking as nominal flows stabilize. However, a recent spike in the NFCI driven by heightened equity and bond market volatility temporarily disrupted this easing trend, though conditions have since begun to moderate in recent weeks.

5. Nominal GDP > 4% = Recession Cancelled

As long as nominal GDP growth remains above the 4% threshold, the case for a U.S. recession weakens substantially. This level is critical because corporate earnings, debt servicing capacity, and labor market stability are primarily tied to nominal not income flows. The current macro environment supports this resilience through four key channels:

• Strong growth in Divisia M4, signaling ample liquidity;

• Rising government interest outlays, acting as income transfers to the private sector;

• Rebounding withheld wage and employment taxes, confirming stable labor income;

• Loose financial conditions, enabling credit expansion and risk-taking.
  

This relationship can be summarized as:

Nominal GDP Growth=Real GDP Growth+Inflation or Nominal GDP Growth = 2.0% RGDP + 2.0% Inflation (according to SEP targets).

If this combined figure stays > 4%, the economy maintains enough cash flow and velocity to offset private sector weakness, effectively canceling the recession call.

This is not a booming, broad-based expansion but it is also far from an imminent collapse. The U.S. economy continues to find support from a set of liquidity-rich mechanisms that are quietly but powerfully sustaining nominal growth. Rising government interest outlays are acting as de facto fiscal transfers, injecting income into the private sector and bolstering spending. At the same time, nominal labor income remains steady, as evidenced by rebounding wage and employment tax receipts, which point to underlying resilience in the job market. Credit and financial risks have eased, with financial conditions remaining broadly accommodative despite recent volatility. And importantly, the monetary base captured more accurately by Divisia M4 has begun to recover after a period of contraction, signaling a return of systemic liquidity. As long as these foundations hold, the economy retains enough momentum to avoid tipping into recession, making the widespread 2025 recession call increasingly difficult to justify.