Notes on the Economy – Q2 2025 Summary

Front-Running the Tariff Bear

The U.S. economy started 2025 with a contraction. The advance estimate shows inflation-adjusted (i.e., real) GDP fell 0.3%, annualized. That is well below the 3.1% and 2.4% growth rates for the third and fourth quarters of 2024, respectively. However, the economy was not dormant. To the contrary, real final sales to private domestic purchasers advanced 3.0%. Real GDP was suppressed because a material portion of the first quarter’s consumption and investment was not provided by domestic production, but by imports, which were up a whopping 41.3%, annualized.

The reason for the surge in imports is straight-forward. Households and businesses stepped up purchases of foreign goods, buying in advance of need in order to front-run the imposition of tariff increases announced by the Trump administration. Unsurprisingly, a sizeable portion of imports ended up in inventories. That inventory accumulation was enough to boost real GDP growth by 2.3 percentage points but not enough to offset the negative impact of 5.0 percentage points exerted by the importation of foreign goods.

The announcement of tariff increases on imports from all of the countries that engage in trade with the United States has raised economic uncertainty around the world, handicapping the performance of the global economy. Economic growth momentum in the global economy is close to a stall. The global Composite Purchasing Managers’ Index (PMI), for example, fell 1.2 points in April to 50.8, not far above the threshold of 50.0 that separates economic expansion from contraction.

HEADLINES – What’s important

1. Beware of an Inflation Head Fake – The impact of tariffs has yet to show up in the inflation data, but it is coming, boosting the overall level of consumer prices (not inflation per se) by about 1.0% to 1.4%.
2. Yes, the Federal Reserve’s (Fed’s) Rate-Cut Cycle Remains on Temporary Hold – Tariffs will put pressure on both sides of the Fed’s dual mandate of low inflation and maximum employment, but one or two rate cuts are still probable in late 2025.
3. Gold and Silver Still Have Upside Potential – Near-term seasonal weakness could hit prices this summer, but double-digit percentage gains are possible over the coming 12 months, while providing a measure of financial disaster “insurance.” 
4. In April, Equities Navigated a Non-Recession Bear Market – However, the economic growth scare is not over; investors should remain globally diversified and consider a tilt toward U.S. domestic small- and mid-caps and foreign developed markets. 

LOOKING AHEAD

The U.S. economy’s transition from a growth spurt in excess of long-run potential to a period of normalcy, has been disrupted by the reaction of households and businesses to the recent tariff imposition process. The tariff-related impact on GDP—most notably its trade- and inventory-related components—should dissipate soon. Exports, imports, and inventories are likely to complete a rebalancing process by early 2026. In contrast, the impact of production inefficiencies created by tariff distortions will remain as long as the tariff increases are in place. That means there will be a permanent reduction in potential real GDP relative to its pre-tariff level and its growth path.

Although tariff increases will likely be negative for economic growth, in the near term other economic policy levers are likely to be moving moderately in the opposite direction. True, the Fed has kept its short-term policy rate target on hold in the range of 4.25% to 4.50% since December 2024, but it is poised to counter weakness in the labor market, and it is quite unlikely to raise the rate in response to a tariff-related bump in prices. More likely, it will lower the rate target in response to a weakening labor market. Fiscal policy appears growth friendly with the extension of the Tax Cuts and Job Act a slam-dunk result of the Congressional budget reconciliation process.

The nearly universal shift in global monetary and fiscal policies during 2024 toward an accommodative stance for economic growth is now being partially offset by the adverse impact of U.S. tariff increases. The International Monetary Fund’s April forecast, for example, projects real GDP growth in the global economy will slow from 3.3% in 2024 to 2.8% in 2025 and 3.0% in 2026, compared to its previous forecast of 3.3% in both 2025 and 2026.