State of the Economy

Predicting the future of U.S. economic growth used to be pretty easy. All you did was take what happened during the previous quarter, then either add or subtract based on your analysis of a host of economic reports. That is part of the reason everyone on television seems to be saying the same thing.

However, as Bob Dylan sang, “The times they are a-changin’.” Why bust your back doing the necessary work when it doesn’t matter what you do?

INVENTORY RUSH, TRADE GAPS AND GDP MATH

During the 1st quarter of 2025, the threat of U.S. tariffs on major trading partners led to a surge in inventory building, pulling forward many planned purchases. Put another way, businesses didn’t want to be caught flat-footed if and when the administration slapped additional taxes on imports. So, they went ahead and got what they thought they needed.

As a result, the trade deficit ballooned. So much so, according to 1st quarter Gross Domestic Product (GDP), the Bureau of Economic Analysis (BEA) estimated that the deterioration in our trade balance took a whopping 461 basis points (4.61%) off of the GDP equation. Conversely, the increase in inventories added back 259 basis points.(1)

All told, the BEA estimated that U.S. GDP shrank 0.5% during the 1st quarter. Obviously, negative signs in front of economic releases aren’t desirable. However, if “we” can easily explain away 4.6% of the 0.5% contraction, as yours truly (and undoubtedly others) did, were things really that bad? Further, what did the future hold?

Well, if we are to believe the economic reports Washington feeds us, we should expect a significant “improvement” in the trade deficit in the BEA’s 2nd quarter 2025 GDP report. As the chart below suggests, the sharp reversal in our trade picture during the last quarter will likely add to the overall GDP equation, perhaps significantly. Further, businesses will have likely worked down their huge increase in inventories.
As a result, the BEA will likely report the trade deficit added to the economy during the quarter and the inventories subtracted from it.

All told, the BEA estimated that U.S. GDP shrank 0.5% during the 1st quarter. Obviously, negative signs in front of economic releases aren’t desirable. However, if “we” can easily explain away 4.6% of the 0.5% contraction, as yours truly (and undoubtedly others) did, were things really that bad? Further, what did the future hold? 

Well, if we are to believe the economic reports Washington feeds us, we should expect a significant “improvement” in the trade deficit in the BEA’s 2nd quarter 2025 GDP report. As the chart below suggests, the sharp reversal in our trade picture during the last quarter will likely add to the overall GDP equation, perhaps significantly. Further, businesses will have likely worked down their huge increase in inventories. 

As a result, the BEA will likely report the trade deficit added to the economy during the quarter and the inventories subtracted from it. 

MONTHLY U.S. TRADE DEFICIT – FROM BAD TO WORSE TO JUST BAD AGAIN.

*Source: Bloomberg Financial

Even so, if others feel like I do, it seems people don’t care as much about the recent GDP data as they once did. After all, IF the economy can shrink 0.5% in the 1st quarter (as reported by the BEA), AND the Federal Reserve (the Fed) didn’t make any substantial changes to monetary policy, well, the Fed must be focused on other things. 

And it is. 

The second paragraph of the Federal Open Market Committee (FOMC)’s June 2025 statement best captures where the Fed’s focus lies: 

“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. Uncertainty about the economic outlook has diminished but remains elevated. The Committee is attentive to the risks to both sides of its dual mandate.” 

Please note items that were not mentioned: 

• The FOMC didn’t mention anything about the 1st quarter 2025 GDP report.
• Believe it or not, there wasn’t any mention of tariffs or presidential social media posts either. 
• It didn’t breathe a word about the trade deficit or inventory growth. 
• Consumer confidence? Business optimism? Corporate profitability? 

While it is difficult to imagine the Fed not caring about those things, none of them made the cut in the official statement. 

Basically, it seems the future of monetary policy in the United States comes down to two things: inflation and the labor markets. So, where were they during the quarter?

INFLATION 

After spiking in June 2022, the trailing 12-month Consumer Price Index (CPI) seems to have found a cooler home in the mid-2% range. In April and May 2025, it was 2.3% and 2.4%, respectively. This is a significant improvement from April and May 2024, with figures at 3.4% and 3.3%. As such, the rate of price increases for consumer goods and services in the U.S. economy appears to be better under control. 

IS INFLATION REALLY THAT MUCH OF A PROBLEM ANY LONGER?

*Source: Bloomberg Financial

However, the Fed hasn’t been ready to claim victory over inflation yet. The reason? Tariffs. 

While it might not admit so in official statements, like it didn’t after the June 2025 FOMC meeting, the impact tariffs might have on the CPI, and other inflation gauges, is significant. 

Consider the following “executive” statement from an economic letter Fed economists Bart Hobijn and Fernanda Nechio released on May 19, 2025: 

“A range of tariffs on U.S. imports has been enacted or considered recently. Trade tariffs can potentially affect price inflation for consumption and investment goods. Estimates suggest that the impact on prices for investment goods is likely to be much larger than for consumption goods. For example, if an across-the- board 25% tariff is fully passed through to finished goods, near-term price increases are estimated to be about 9.5% for investment goods and 2.2% for consumption goods. These price increases for investment goods can have important implications for businesses’ investment decisions.” (2)

Understandably, the Fed is hesitant to cut the target overnight lending rate. However, in this business economist’s humble opinion, inflation ultimately comes down to supply, demand and the amount of money floating around the economy. As such, IF there is not a commensurate increase in the money supply, tariffs likely wouldn’t have the impact on consumer prices that the Fed fears. 

The consumer will simply run out of cash, and demand will lessen. If that happens, prices should fall over the long-term. However, in the short-term, a sudden increase in consumer prices due to tariffs could have a detrimental impact on overall economic activity. After all, the less people consume, the less companies will need to produce. The less they need to produce, the fewer workers they need to employ, and so on and so forth. 

LABOR MARKETS 

As for the labor markets and employment, the U.S. economy has been surprisingly resilient in creating jobs since the end of 2020. While monthly job growth has decreased somewhat over time, it has been a remarkable run for new payrolls. As the chart below demonstrates, through May 2025, payrolls have increased every month since January 2021. 

JOB GROWTH HAS BEEN WEAKENING 

*Source: Bloomberg Financial

However, as the chart also shows, monthly job growth appears to be increasing at a decreasing rate. In other words, the trend is slowing. 

Further, the type of jobs the economy has recently been creating is a little concerning to me. 

• For instance, according to the “Employment Situation – May 2025,” 3 prior to any adjustments made after June 30, 2025, the economycreated 1.733 million newpayroll jobs over the 12-months ending in May 2025. That is pretty good news, right? However: 

• • 312,000 were in ‘state & local government 

• • 923,000 were in private education and health services 

• • 262,000 were in leisure and hospitality 

In May 2024, these three sectors accounted for roughly 40.2% of all payroll jobs in the U.S. economy. However, they accounted for 86.4% of all official payroll growth. 

The rest of the economy, the remaining 59.8%, officially created only 236,000 new payrolls jobs over those same 12-months – just under 20,000 jobs per month. 

Again, prior to any revisions to the “Employment Situation – May 2025” report after June 30, 2025.

IN CONCLUSION 

So, how would one describe an economy with modest levels of inflation, as defined by the 12-month CPI, and modest levels of job growth, as I outlined in the previous two paragraphs? In this instance, the equation for economic growth is: modest + modest = modest. 

However, due to the spectre of tariffs the administration has hung over the economy, you could write that simple equation as: 

Modest + Modest +/- Tariff Uncertainty = Anyone’s Best Guess (But Probably Modest)

In the end, predicting the future of U.S. economic growth used to be pretty easy. All you did was take what had happened the previous quarter, and either add or subtract based on your analysis of a host of economic reports. Easy peasy, nice and easy.

These days, when you throw in punitive tariffs and a president who can move the markets with a single tweet? Again, as Dylan used to sing: “The times, they are a-changin’.”

SOURCES:

1. Bureau of Economic Analysis: Gross Domestic Product, 1st Quarter 2025
2. Federal Reserve Bank of San Francisco: The Effects of Tariffs on Inflation and Production Costs
3. Bureau of Labor Statistics: The Employment Situation – May 2025

This content is part of our quarterly outlook and overview. For more of our view on this quarter’s economic overview, inflation, bonds, equities and allocations, read the latest issue of Macro & Market Perspectives.

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