Surprise GDP Decline and a Mixed Economic Landscape
The U.S. economy unexpectedly contracted in the first quarter of 2025, with the gross domestic product (GDP) declining at an annualized rate of 0.3%. This marks the first such contraction since 2022. A primary factor in this downturn was a significant surge in imports, as businesses increased their inventories in anticipation of upcoming tariffs. This import surge substantially impacted overall GDP, resulting in a record drag from net exports, subtracting nearly five percentage points. While consumer spending saw a modest increase of 1.8%, the slowest pace since mid-2023, federal government spending also decreased. Consequently, the dynamics of international trade emerged as the dominant influence on the quarter’s economic contraction.
This increase in imports was a direct consequence of the Trump administration’s evolving trade policies, with initial tariffs taking effect during the first quarter and further escalations anticipated in the second. The urgency to import goods pushed the growth rate of imports to its highest level since the recovery from the pandemic in the third quarter of 2020. Despite the reported decline in headline GDP, some economists have pointed to underlying resilience in domestic demand, evidenced by a 3% rise in final sales. It is important to note, however, that this GDP report reflects past economic activity, and ongoing uncertainty surrounding trade tariffs and volatility in the financial markets has continued into the current quarter.
Looking forward, businesses and economists are increasingly concerned that these tariffs could lead to higher consumer prices and potentially further negative GDP growth and job losses if the administration does not adjust its approach or secure trade agreements. The Federal Reserve also faces a complex situation, as tariffs could contribute to both increased inflation and weaker economic momentum, thereby complicating its dual mandate of maintaining price stability and full employment.
Strong Tech Earnings Contrast With Broader Uncertainty
The current earnings season has revealed a bright spot in the performance of major technology companies. Alphabet, Microsoft, and Meta have all reported robust first-quarter earnings. Collectively, these three firms achieved an average year-over-year revenue growth of 13% (ranging from 12% to 16%), while their operating profits increased between 13% and 27% over the same period. These results suggest that certain segments of the economy continue to perform well, with spending on areas like advertising, cloud computing, and enterprise applications holding up against earlier concerns of a slowdown. Furthermore, these tech giants are making substantial ongoing investments in artificial intelligence (AI) infrastructure, with combined capital expenditure plans exceeding $200 billion for the year, largely directed toward AI data centers.
However, the economic landscape appears less favorable for companies in other sectors, such as travel and leisure. Executives in the airline and hotel industries have noted that weaker consumer sentiment and expectations of rising prices due to tariffs are negatively impacting bookings. Specialty retailers also face a challenging environment, lacking the scale of larger competitors like Amazon, Walmart, and Costco, which allows for more favorable negotiation of tariff impacts. A key question remains whether new trade deals will be established before existing pre-tariff inventories are depleted.
The recent GDP report suggests that many companies did indeed build up inventories ahead of the “liberation day” tariffs. Because import figures are subtracted from GDP to avoid double-counting when goods are sold, the report highlighted a -5% contribution from net exports, largely due to the high volume of imports—a figure significantly larger than in typical periods. Data on the “change in private inventory” suggest that there could be several months’ worth of extra inventory currently held. Consequently, the ultimate impact of the tariffs on consumer spending will depend heavily on the timing of any future trade agreements.
Fed Navigates Employment and Inflation Amidst Uncertainty
Recent employment data indicates a potential softening in the labor market. This morning’s initial unemployment claims report revealed a spike in filings to 241,000, exceeding the anticipated 225,000. While this is just one data point, it aligns with other reports suggesting a weakening in job openings and announced layoffs from several large companies, such as UPS, indicating a likely trend toward worsening unemployment as the year progresses. However, the Federal Reserve has signaled its intent to await more definitive confirmation of this deterioration in official government reports before considering further reductions in interest rates.
Inflation continues to be a concern, remaining above the Fed’s target rate of 2%. The first-quarter core PCE (personal consumption expenditures) price index, the Fed’s preferred inflation gauge, came in at 3.5%, an increase from the 2.6% recorded in the fourth quarter of 2024. A stabilization or decrease in the inflation rate would provide the Fed with more flexibility to support economic growth through a more accommodative interest rate policy. Given the inflationary expectations associated with the Trump administration’s trade and tariff policy changes, most economists currently do not anticipate any interest rate cuts before June.
Finally, the S&P 500 index has shown a strong recovery, increasing by 11% since its low on April 8. However, there are concerns about the sustainability of this sharp rebound, particularly given the high degree of uncertainty surrounding tariffs and their yet-to-be-fully-realized effects on businesses and consumers. Many companies have adjusted their outlooks to reflect this uncertainty. In our view, the current economic environment feels more like the eye of a storm rather than a clear path forward, and therefore, a cautious approach to investment remains warranted. Our seatbelt sign remains “on.”
Country singer Tim McGraw turns 58 today, actor Jamie Dornan (Fifty Shades of Grey) turns 43 and quirky filmmaker Wes Anderson turns 56.
Christopher Gildea 610-260-2235