After a brief reprieve from all the recession talk while the Fed was raising rates to decades-old high watermarks, the ‘R’ word has come back into vogue once again post-Liberation day. The Q1 report for real GDP did produce a negative reading to open 2025, as the economy contracted -0.3%, according the Bureau of Economic Analysis (BEA) advanced estimate. Thus, using the textbook definition of two consecutive quarters of negative real GDP, one could say the U.S. economy is half-way to a potential recession. However, we say there is more to this designation that needs to be looked at.
This brings us down memory lane a bit to 2022, when economic activity did contract for two quarters in a row to begin that year, and everyone seemed to be falling over themselves trying to say whether or not the US had entered into an actual recession. Interestingly, the 1Q 2025 decline was the first shortfall since that 2022 period.
So, lets’ take a deeper dive into the BEA’s Q1 data to get more clarity. When looking at real GDP statistics, one can break down the economic engine into five cylinders: personal consumption, investment, net exports (trade), inventories and government spending. Three out of the five cylinders actually provided positive contributions (consumption, investment & inventories) while two (next exports & government spending) came in on the negative side of the ledger.
On the surface, one may have assumed that if 3 out of 5 contributors were positive, then overall real GDP may have eked out a positive performance. However, imports surged more than 41% which completely eclipsed any positive factors. This large increase appears to be a front-running to avoid tariffs and will more than likely not be repeated. If that is the case, it seems highly plausible that there will no be enough demand to take down such a supply surge which could result in a build-up inventories ahead. While inventories did rise in Q1, the increase came nowhere near matching the surge in imported goods.
If this import surge is an anomaly of sorts, is there a better statistic to gauge the underlying economy? Yes, real final sales to private domestic purchasers. This line item includes only consumption and investment, arguably the two most important aspects of the economy as they measure underlying demand, and in Q1, it rose by +3%, maintaining the solid trend that has been in place for the last two years.
That brings us to the Fed. In no surprise, the policymakers kept rates unchanged at the May FOMC meeting, but moving forward their task will more than likely become more challenging. Specifically, how do you sift through upcoming economic data to sort out tariff-related ‘noise’?
One thing investors may be able to take some comfort in is that the labor markets and underlying demand appeared to be on relatively solid footing heading into the upcoming period of uncertainty. We’d take that over the alternative anytime.
