Q1 2025 Economic Summary

Introduction

The first three months of 2025 have been nothing short of chaotic as economic sentiment shifted significantly halfway through the quarter. In January, following an early-month decline, equities continued their upward advance as bonds ended the month modestly in positive territory. Prior to President Trump’s inauguration, market participants were generally constructive on the prospects for the new year with expectations of a more business and regulation-friendly environment going forward. By mid-February, the bloom had started to come off the rose as Trump’s aggressive tariff agenda began to impact investor sentiment as concerns about the growth of the economy began to legitimately come into question. As a result, the S&P 500 registered a slightly negative monthly return as the rates markets rallied meaningfully more than counteracting the decline in equities for diversified investors. Equities continued to decline through March, touching a full 10% correction before rebounding as interest rates retraced some of the drop lower by the end of the month. As we dissect the past three months and then look ahead to our future, keep in mind the markets’ general distaste for uncertainty and how this impacts consumers and the economy in general. Suffice to say, we certainly find ourselves in interesting times.

The Economy

To set the stage for 2025, preliminary data for Real Gross Domestic Product for the fourth quarter of 2024 increased at an annual rate of 2.3%, with final figures still pending release. This represents a slowdown from the 3.1% pace recorded during the third quarter. The annualized pace of growth for the entirety of 2024 represents a reasonably constructive 2.8% growth rate. In short order, however, as the first quarter of 2025 got underway this soon changed.

As the year began, early expectations for economic growth for 2025 were consistently forecasted around the mid-2% range, including from yours truly. More recently, however, largely due to President Trump’s aggressive and unpredictable tariff policy initiatives concerns about economic growth prospects have dimmed considerably. Updated forecasts suggest the potential for negative economic growth at some point this year and a meaningful decline for annualized GDP well below the 2% level. Additionally, the dreaded “R” word has begun to enter the broader conversation as concerns about the potential for a recession have become elevated. The likelihood of the Fed successfully navigating a soft landing has become compromised in recent weeks. Almost more concerning is the increased threat of stagflation as negative economic impacts result in a slowdown of the economy as inflation and unemployment rise.

Turbulent, unpredictable, and unsettled are just a few of the adjectives that can be used to describe the economy going forward. International and financial tension have led to a consensus opinion that economic growth will be lower as consumer confidence has waned in recent weeks.

The Federal Reserve

Despite turmoil dominating both headlines and markets through much of the first quarter, the Fed has maintained a steady hand and disposition in the face of such adversity. Chair Powell and Company continue to reiterate patience while implementing policy as demonstrated by numerous public statements and through their direct action in holding the Fed Funds Target Range steady at the 4.25 - 4.50% range.

According to the most recent Summary of Economic Projections (SEP), also known as the “Dot Plot,” the committee is projected to cut twice in 2025, twice in 2026, and once in 2027. Notably, for the remainder of the year, following the most recent release, voting shifted slightly more hawkish, as demonstrated in the below chart (red dots). Despite this shift in voting sentiment, the median level (blue diamond) remained unchanged from the December 18 meeting. Per Chair Powell at the press conference following the meeting, members became more concerned about potential inflationary pressures resulting in the shift in dot projections.

Fed officials face the unenviable task of navigating the shifting dynamics of President Trump’s tariff policies and their impact on the economy as consumer confidence has dropped and consumer spending is declining. Furthermore, despite February headline data showing that price increases decelerated, the devil is in the details. Some components of inflation, which pass through to the Fed’s preferred inflation metric (PCE), did not decline during the month suggesting that inflation remains quite sticky. Despite somewhat conflicting interpretations surrounding recent economic data, market forecasters are divided between expectations of fewer or greater cuts by the FOMC. The lack of consensus highlights the uncertainty within the market.

The Inflation Picture

Progress regarding the path of inflation towards the Fed’s 2% target remains somewhat mixed and definitively challenged. On the surface, early data in 2025 demonstrated slight progress heading towards more desirable lower levels. In some ways, however, larger-picture fundamental concerns raise the specter that inflation may be on the rise. Even Chair Powell has suggested that “further progress may be delayed.” As the below chart highlights, core-CPI, core-PPI, and core-PCE demonstrate a generally flat sideways trend in recent months. However, the most recent core-PCE data in red (the Fed’s preferred measure) demonstrated a notable uptick on a MoM basis resulting in YoY levels ticking upwards to 2.8%. Given that tariff-induced inflation impacts have yet to be fully realized in the data, given the backward-looking nature of these measures, further upward pressure is a likely probability.

The constantly changing and contentious trade war situation has experts sharply divided regarding the inflationary impacts of President Trump’s tariff initiatives. Furthermore, the lack of clarity regarding the justification for the imposition of tariffs has changed as commentaries from White House staff add another layer of uncertainty to the equation. Are the tariffs intended to motivate trade partners to change their behaviors to combat unfair trade practices? Is stopping the flow of fentanyl across the borders, as has been suggested, yet another reason? How about increasing border security by trade partners to help stop illegal immigration and human trafficking? Additionally, revenue-producing impacts of tariffs have been suggested to help balance the budget. Without a clear understanding of the desired impact of tariffs, the markets will continue to discount economic growth until more clarity is achieved.

A simplified definition of inflation includes a sustained increase in prices over a period of time. With that in mind, one camp contends that the tariffs will only result in a one-time increase in prices as opposed to a sustained period with rising prices. Another argument suggests that consumers will adjust behavior and purchase domestic goods, avoiding the higher prices of imported goods hit with tariffs. Yet another perspective states that higher costs will be more steadily passed on to consumers over time and will look very much like traditional inflation. Chair Powell, in his most recent press conference, suggested that voting members most assuredly believe that some elements of tariffs are contributing to the increased inflation expectations. Regardless, future inflation expectations remain a looming question for market participants to decipher and react to as more information becomes available.

The Consumer

In previous editions, we have highlighted the importance of the consumer to the US economy. Specifically, consumer spending comprises about 68% of GDP. It should come as no surprise that declines in GDP forecasts are most likely led by a decline in consumer spending and sentiment. In short, if consumers lack an optimistic outlook about their collective prospects for prosperity, they will be less willing and/or able to spend and provide stimulus and growth to the economy.

With that in mind, the University of Michigan Consumer Sentiment Index fell sharply in the March survey following a meaningful decline the prior month. The index fell to 57.9% reflecting the lowest reading since November 2022 and approaching the June 2022 multi-decade low of 50.0. Given the importance of the consumer for the health of the economy, it comes as no surprise that a decline in confidence (generally considered to be a leading economic indicator) portends a slowdown in consumer activity.

Similarly, the Conference Board Consumer Confidence Index demonstrated a notable decline. The index is benchmarked to 1985 at a value of 100. Values below 100 indicate pessimism and values over 100 indicate optimism on the part of consumers. As indicated in the below chart, each of the past 4 months has demonstrated a decline from the post-election bump, with February and March falling below the crucial 100 barrier. Combining the University of Michigan and Conference Board Consumer Confidence Indexes, the net tone of both reports is decidedly negative on the part of the consumer.

It is fair to acknowledge that both of these indexes are surveys as opposed to hard data, suggesting that consumer action may differ from their less-than-rosy outlook on the economy as disclosed in a survey. The mantra, “actions speak louder than words” may come into play as we move forward to determine if consumers will alter buying behavior. Alternatively, consumers could continue with the heavy consumption activity that has been the norm over the past year despite conveying negative sentiments in surveys. Keep a close eye on consumer action to help understand the impacts on the economy.

The Labor Market

The employment picture remains relatively steady, but it is worth noting the slight cooling of the labor market over the past year has persisted into the first quarter. As evidenced in the below chart, the unemployment rate continues to hover just above the 4% threshold with February data coming in at 4.1%. Nonfarm Payrolls, representing job growth, came in at a relatively sluggish 151k jobs added in February. The trajectory for payroll data has been relatively consistently declining over the past two years. The trailing twelve-month average from February 2023 was +351k, one year later, this figure had declined to +182k, and most recently, the average is only +162k jobs created. Importantly, four out of the past twelve months have had less than +100k jobs created. The combination of a loosening labor market following the post-pandemic surge and steadily declining job creation does not bode well for the future growth of the economy.

A notably welcome development regarding employment is the fact that as inflation has come down from the very elevated levels reached during the pandemic unemployment has remained in check. Historically, unemployment rises as inflation falls, adding to the need for the Fed to intervene with a more aggressive rate-cutting policy to stimulate the economy and encourage economic growth and hiring. Such an occurrence has not been taking place in recent months reducing the need for the Fed to act with policy action to lower rates.

The US jobs market is also dealing with the unusual dynamic of the impact of the Trump administration’s focus on cutting federal headcount. An even more unusual twist is the likelihood that the impacts from DOGE to improve efficiencies throughout the federal government will eliminate contracts to outside businesses and effectively push even more people into the unemployment line. These efforts could strain the current balance that has held unemployment steady of late.

Interest Rates

The interest rate picture has been volatile in the early part of 2025. As demonstrated by 10-Year US Treasury notes, rates peaked in January near the 4.80% level before sharply falling and testing 4.10%. With the overnight lending rate, known as the Fed Funds Effective Rate, pegged to around 4.33%, it is difficult to justify longer-term borrowing including US Treasury instruments maintaining yields meaningfully lower than current range around the 4.25 – 4.40% area.

Despite long-end interest rates declining, the shape of the US Treasury curve remains upward, sloping beyond the 2-Year area of the curve. The fact that the curve has retained its normal positive slope after the longest period of inversion in history is a constructive sign for the market. The Fed’s continued stance to keep its overnight lending rate at a more restrictive level, given ongoing concerns about inflation, is causing the very front end of the curve to remain inverted. Certainly, the disinversion that has already occurred is a positive step for businesses reliant upon an upward-sloping curve to help margins, however, a complete re-steepening is required to truly be helpful to banks, credit unions, financial services companies, and others relying upon a normal market environment to drive margins and more favorable business results.

Naturally, higher yields have been a challenge for the housing and real estate markets as mortgage rates have remained elevated and housing prices have only just recently started to fall in select markets. Homebuyers who have been hopeful that 30-year rates would meaningfully decline from the 7% range have only experienced modest relief. Given the limited expectation of significantly lower rates from the Fed, it remains unlikely that sub-6% rates will be available anytime in the near future. Keep in mind, even if the Fed lowers the target Fed Funds Rate, mortgages are priced off 10-Year Treasury and may not react as sharply to Fed policy action.

The Political Environment

The Trump administration has contributed to an increased level of uncertainty about the path forward for the US economy. Uncertainty, along with the potential economic implications of the administration’s tariff policies, has undoubtedly led to a decline in expected economic growth as measured by GDP. Most importantly, Trump, along with administration officials, including Treasury Secretary Scott Bessent, have acknowledged that they are not only expecting some pain to be felt within the economy, but they welcome it as a necessary “detox” to achieve their goals and create a stronger economy going forward.

Specifically, Trump’s aggressive and ever-shifting tariff policies introduce some challenging elements for the markets to digest. One of the unusually difficult aspects has been the shifting narrative regarding the rationale for instituting restrictive trade policies. At various times, the rationale has included border defense, immigration, cross-border drug trafficking, economic protectionism, improving the trade imbalance, and serving as a negotiating tactic to encourage counterparties to take a seat at the bargaining table. Without a clear understanding of the end goals, market participants have a hard time determining the timeframe and success of any such endeavor.

The potential economic implications of a trade war remain a topic of debate. As mentioned above, however, the economy is expected to retrench going forward. The potential inflationary impacts are less uniformly understood. On the surface, one expects tariffs to raise the prices of consumer goods and contribute towards an uptick of inflation. One outcome suggests the higher cost of imported goods could be passed along to the consumer. An alternative argument suggests that consumer demand could shift towards domestically produced goods with the higher demand causing prices to rise. Yet another perspective implies that concentrated and one-time price increases as a result of tariff policies, though detrimental to the consumer and the economy, will not be inflationary as the price increases are not sustained over a period of time. Furthermore, if the threat of tariffs is successful in reducing tariffs placed upon US goods from other countries but are not fully implemented, prices may never be affected.

The Stock Market

Equities have experienced their share of anxiety and challenges thus far in 2025. Despite early optimism and expectations of sustainable growth leading to the S&P 500 reaching a new all-time high in February, the market has more recently experienced a pull-back. Economic growth prospects resulting from the looming trade war have been the primary reason for market participants questioning the sustainability of the early-quarter move.

Despite the ebb and flow of the market activity, as of this writing, the S&P 500 is only lower by around 2% from December’s close. Additionally, it has rebounded from a -6.1% YTD return in mid-March, which constituted a -10.1% decline from the February peak. Keeping in mind that a 10% decline is usually considered a corrective move, the question arises as to whether a near-term low has been established and the market will resume its upward trajectory.

The previously discussed selloff was heavily focused upon the Mag 7, as the S&P 500, excluding the Mag 7, had a net positive return during the same period. A slowing US economy, whether driven by trade war concerns or other reasons inevitably led to questions about the continued sustainability of the outsized earnings growth for Big Tech. Therefore, an adjustment to expectations from admittedly atmospheric earnings levels to more normal levels (for high-flying tech stocks) in line with the 20-25 times valuations provides rationale for the price action. Though it has been well-known that the tech-heavy index does not adequately represent the broader market. The first quarter price action highlighted the danger of incorrectly assuming the index represents the entire market.

The Outlook

For the reasons outlined above, I am concerned and skeptical that the economy will continue to grow at the relatively solid pace experienced throughout 2024. The near-term implications of the Trump administration’s tariff policies will likely continue to be a challenge for the economy and my 2025 GDP forecast has fallen from around 2.5% to around 1.6%. Furthermore, I would not be surprised to experience negative growth at some point for one quarter in 2025 because of the challenges facing the economy. The consumer engine driving economic growth is already experiencing the early effects of a slowdown and I expect things to get worse before they get better. I place a relatively small likelihood (10%) that the economy will fall into a recession, and I expect the Fed to continue to navigate a soft landing despite the challenging environment. Stagflation remains a concern as slowing growth and higher inflation elevate this threat, but I am hopeful the economy can avoid this even worse scenario in the coming months.

Presently, the FOMC Dot-Plot suggests that officials are expecting to cut rates twice this year. I only expect one rate cut, with an outside chance at zero cuts, as the inflation picture fails to make material progress toward the Fed’s desired 2% target. Though I am not suggesting that the Fed will alter or abandon their 2% inflation target that has been in place since the 90s, they may get more comfortable with rates in the mid-2% range. This thought process does not call for policy action and is in line with their oft-stated patient approach that has been espoused in recent months. Furthermore, the employment picture should remain stable as the unemployment rate holds around the recent range (4.0 – 4.2%), eliminating another justification for stimulative fiscal policy by the Fed.

Regarding interest rates, I am slightly amending my forecast but still expect rates to remain meaningfully above the 4% threshold. There is still a chance that rates can revisit the 4.80% high reached earlier this year, and I do not expect rates to maintain meaningfully lower levels. I have less conviction that rates could exceed the 5% threshold this year but attribute a small possibility that this could come to fruition. Given my expectation for fewer rate cuts and little change to my inflation forecast, I do not expect rates to sustain lower levels this year. I continue to expect the higher for longer narrative for interest rates in part due to the Fed maintaining their target rate at a higher level thereby limiting the market’s ability to push long-end rates meaningfully lower.

The equity market will likely continue to experience volatility as the impacts of tariffs (both threatened and enacted) weigh heavily upon corporate growth prospects. I anticipate further weakness at some point as the market deals with the impending lower growth environment. I expect a further decline in the S&P 500, offering investors an opportunity to buy the dip before the market recovers due to Trump’s pro-growth policies take effect. The slowing domestic economy will weigh upon the market, thus my expectations are for a dip in the S&P before it ultimately improves after positive influences eventually take hold.

An index is unmanaged and not available for direct investment. Definitions sourced from Bloomberg.

The Bloomberg Barclays Global Aggregate Negative Yielding Debt Market Value Index represents the portion of the Bloomberg Barclays Global Aggregate Index that measures the aggregate value of global debt with a negative yield. • The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. • The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.• The Cboe Volatility Index® (VIX) is a calculation designed to produce a measure of constant, 30-day expected volatility of the US stock market, derived from real-time, mid-quote prices of weekly S&P 500® Index (SPX) call and put options with a range of 23 to 37 days to expiration.• The ICE BofA MOVE Index is a yield curve weighted index of the normalized implied volatility on 1-month Treasury options. It is the weighted average of implied volatilities on the CT2 (Current 2 Year Government Note), CT5 (Current 5 Year Government Note), CT10 (Current 10 Year Government Note), and CT30 (Current 30 Year Government Note), with weights 0.2/0.2/0.4/0.2 respectively.• The Markit CDX North America Investment Grade Index is composed of 125 equally weighted credit default swaps on investment grade entities, distributed among 6 sub-indices: High Volatility, Consumer, Energy, Financial, Industrial, and Technology, Media & Tele-communications. Markit CDX indices roll every 6 months in March & September. • The Markit CDX North America High Yield Index is composed of 100 non-investment grade entities, distributed among 2 sub-indices: B, BB. All entities are domiciled in North America. Markit CDX indices roll every 6 months in March & September. • The U.S. Dollar Index (USDX) indicates the general international value of the USD. The USDX does this by averaging the exchange rates between the USD and major world currencies. Intercontinental Exchange (ICE) US computes this by using the rates supplied by some 500 banks.

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