US GDP (Q1 2025 – second estimate)

Tariff anxiety and policy uncertainty obscure the economic outlook

• Real GDP contracted 0.2% in Q1 2025, up from a 0.3% contraction in the first estimate, as weaker consumer spending growth was offset by a stronger inventory buildup. The GDP print reaffirms that tariff anxiety led to a rush for imports in the first quarter. Businesses stocked up on merchandise ahead of the duties while consumers rushed to the stores to avoid paying higher prices.
  
  
• Recent economic data suggests that some of the front-loaded demand spilled over into the second quarter. However, the outlook points to an increasingly visible pullback in spending as elevated prices begin to weigh on private sector activity. The US Court of International Trade suspended newly imposed tariffs on imports from China, Canada and Mexico, along with the universal 10% duties, ruling that the use of emergency powers to justify the duties was unlawful. While the decision offers potential short-term tariff relief, it introduces greater ambiguity around the future direction of US trade policy, particularly as the ruling faces appeal.
  
  
• What are the main takeaways?
   
  • Imports surged 43% — the largest since 1974 excluding the post-pandemic rebound — as businesses front-ran tariffs and filled up inventories. Net trade represented a 4.9 percentage points (ppt) drag on GDP growth that was partially offset by a 2.6ppt contribution from inventories.
    
    
  • Domestic demand was artificially robust in Q1, with final sales to private domestic purchasers up 2.5% on the quarter and 2.9% year over year (y/y) on a pull-forward of demand. Still, gross domestic income (GDI) and gross domestic output contracted 0.2%, in line with GDP — pointing to soft income momentum heading into Q2.
    
    
  • The key private sector surprise was business investment growth accelerating to 10.3% on a 24.8% surge in equipment investment. Information processing equipment skyrocketed 75%, adding 1ppt to GDP growth — the largest boost ever.
    
    
  • Consumer spending, meanwhile, was revised to a subdued 1.2% advance — its weakest since Q2 2023. While consumers rushed to front-run tariffs in March and April, spending on durable goods fell 3.8% due to a weak start to the year. Importantly, spending on services was the softest in two years, with more cautious spending on recreation and dining out.
    
    
  • Government spending contracted by the most in three years, down 0.7, with federal government outlays falling 4.6% — also the largest decline in three years — and state and local spending growth easing to 1.7%.
    
    
  • Headline and core personal consumption expenditures (PCE) inflation were stable at 2.5% y/y and 2.8% y/y, respectively, but monthly data shows that inflation was still converging toward the Federal Reserve’s 2% target in April. Of course, this was before the tariff-induced inflation reacceleration.
    
    
  • Corporate profits (with inventory valuation and capital consumption adjustments) fell $118b in Q1 with domestic nonfinancial profits down $97b, domestic financial profits up $9b and international profits down $31b. Profit margins eased from 13.5% of GDP to a still elevated 13%.
    

Private sector sentiment remains notably subdued amid signs of underlying economic fragility. Labor market softening, margin pressures and flagging retail activity underscore the gradual but persistent pass-through of elevated tariffs. Inflationary headwinds are re-emerging, eroding real incomes, while rising bond yields — fueled by fiscal concerns surrounding proposed tax legislation — are increasingly curbing capital expenditure. We expect demand erosion to become more evident in the weeks ahead.
 

In a surprising move, the US Court of International Trade suspended newly imposed tariffs on imports from China, Canada and Mexico, along with the universal 10% duties, ruling that the use of emergency powers to justify the duties was unlawful. While the decision offers potential short-term tariff relief, it introduces greater ambiguity around the future direction of US trade policy, particularly as the ruling faces appeal. This legal development amplifies longer-lasting uncertainty for businesses navigating cross-border supply chains.
 

The court’s decision follows another notable shift in US trade posture. Just weeks earlier, the administration enacted a 90-day reduction in tariffs on Chinese imports, slashing rates from 145% to 30%, with Beijing reciprocating by easing tariffs on US goods from 125% to 10%. Although the average US tariff rate has declined from 25% to 14% as of late May, it remains the highest since 1939. If upheld, the US Court of International Trade’s suspension would lower the average tariff rate further, to 4.6%.
 

We have not yet factored this potential easing of tariffs into our baseline. Indeed, the administration may pivot toward more established trade authorities — such as Section 232 (national security), Section 301 (unfair trade practices) and Section 122 (temporary tariffs to address trade imbalances). Instead, our recent 0.2ppt upward revision to real GDP growth — to 1.3% in both 2025 and 2026 — reflects the earlier rollback of China tariffs. That said, we still expect growth to approach stall speed by Q4 2025, reaching just 0.6% y/y. We have lowered the probability of a recession within the next 12 months from 45% to 35%, though risks remain tilted to the downside.
 

For the Fed, tame inflation dynamics (for now) and resilient labor market conditions support the case for holding rates steady beyond midyear. With little clarity on the final status quo for trade policy and Fed policymakers unlikely to preempt any growth or inflation developments, we now only anticipate two Fed rate cuts, and believe the first rate cut will come in September.