U.S. economy slows

Unusual activity contributed to the U.S. economy’s first-quarter 2025 decline. According to the U.S. Bureau of Economic Analysis, Gross Domestic Product (GDP) growth dropped 0.5% in the year’s first three months. The decline is mainly due to a surge in imports, which reduces U.S. GDP unless offset by a larger increase in exports from the U.S. to other countries. The spike in imports likely reflects companies anticipating higher tariffs on many foreign goods, and the GDP result marked the first quarterly decline in two years. ¹

U.S. Quarterly GDP Real Growth

The increase in imports reduced GDP growth by more than 4%. Private investment added just under 4% to growth. Consumer spending was a modestly positive contributor, while government spending declined slightly. ²

“The import number’s drag likely won’t be a factor when second quarter GDP is released at the end of July,” says Rob Haworth, senior investment strategy director with U.S. Bank Asset Management Group. “Based on shipping activity, we observe fewer goods entering the country, which indicates that in the first quarter, U.S. purchasers of foreign goods were trying to buy before new tariffs took effect.”

Sliding consumer sentiment

In the first quarter, consumer spending, as measured by Personal Consumption Expenditures (PCE), increased by just 0.5% (annualized rate). In comparison PCE rose by 2.8% in 2024. ¹ “While consumers may not be as strong as we initially thought, they are still spending,” says Haworth. “As long as the labor markets and wage growth remain solid, consumers will be in a position to spend.”

A key indicator of consumer sentiment, compiled by the University of Michigan, showed an encouraging sign. After falling during the first five months of 2025, consumer sentiment rebounded in June. ³

“Consumer confidence surveys are unreliable signals of future economic performance,” says Haworth. “A better correlation is found in jobless claims and real wage growth.” To this point, both initial weekly jobless claims and annual wage gains remain relatively stable, sending no major warning signs. “Despite how consumers respond to surveys, if they have jobs, they still tend to spend money,” says Haworth.

What’s ahead for consumers

Consumer spending accounts for nearly 70% of U.S. GDP and remains the key to ongoing economic growth. An important question is whether consumers can maintain spending levels to keep the economy growing. Eric Freedman, chief investment officer for U.S. Bank Asset Management Group, expresses a note of caution. “Data shows that lower income and some middle-income consumers are feeling pressure. The combination of higher interest rates and higher costs continue to weigh on them.” Freedman says if interest rates remain elevated, consumers will feel more pressure.

U.S. retail sales grew at an annualized 4.5% pace between March and May 2025 compared to the same point a year earlier. The pace of sales slowed between April and May. ⁴ “Consumers are hanging on, trying to make decisions around inflation expectations and how that will impact buying decisions,” says Haworth.

What remains to be seen is how President Donald Trump’s tariffs will affect consumer behavior. While some new tariffs on key trading partners were implemented in recent months, many of the Trump administration’s proposed tariffs are on pause. The overall economic impact remains uncertain, but it adds a level of unpredictability for both businesses and consumers.

The Federal Reserve lowers expectations

One sign of potential economic headwinds comes from the Federal Reserve's (Fed’s) Federal Open Market Committee. In the Committee’s latest Summary of Economic Projections (June 2025), it continued lowering its forecast for 2025 GDP growth, while modestly increasing unemployment and inflation expectations. ⁵

Despite signs of slower economic growth, through 2025’s first half, the Fed held the line on the federal funds target rate. This short-term rate is influential for borrowing costs such as auto loans and home mortgages.

Fed Chair Jerome Powell says concerns about the inflationary effects of tariffs add to the Fed’s rate-cutting caution. “In effect, we went on hold when we saw the size of tariffs and essentially all inflation forecasts for the United States went up materially as a consequence of the tariffs,” says Powell.

In 2024’s closing months, the Fed cut rates by 1.0%, based on signs of labor market weakness. Since that time, the labor market stabilized. While monthly job gains are slower than they have been in recent years, they are keeping pace with population growth,” says Haworth. “If the economy experiences both rising inflation and higher unemployment, the Fed doesn’t have tools to address those concerns simultaneously.” This so-called “stagflation” scenario is considered a potential outcome of increased tariffs if they have a negative economic impact.

While the economy may be slowing, Haworth is optimistic that a recession can be avoided in the near term. “Consensus expectations are for a bit of a second-quarter GDP bounce, which will help offset the first-quarter decline,” says Haworth.

Implications for investors

Throughout 2024, the economy’s ongoing strength helped corporations meet or exceed earnings expectations. For the second consecutive year, the S&P 500 generated total returns topping 25% in 2024. ⁶ Haworth says the earnings outlook remains favorable for 2025. “There appears to be a sufficient level of economic growth to keep the market buoyant, although likely with a degree of volatility.” Favorable earnings and economic fundamentals helped drive the S&P 500’s strong second-quarter results. After dropping to a 15% year-to-date decline in early April, the S&P 500 is up 6.20% as of the end of June 2025.6 During that period, investors reacted favorably as modest inflation and unemployment persisted, and corporate profits remained stable.

Consider reviewing your current portfolio with your wealth management professional to determine if it’s consistent with your long-term goals and positioned to meet your needs in today’s market and economic environment.

Note: Diversification and asset allocation do not guarantee returns or protect against losses. The Standard & Poor’s 500 Index (S&P 500) consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The S&P 500 is an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results.