U.S. economy slows

Amid an uncertain economic environment complicated by significant trade policy changes, the U.S. economy contracted modestly in the first quarter. The 0.3% annualized decline in first quarter Gross Domestic Product (GDP) was the first quarterly contraction since 2022.¹ It does not yet signify the start of a recession.

In large part, the negative turn in first-quarter GDP can be attributed to increased spending on foreign-produced goods. This may have been, in part, a matter of consumers and businesses trying to get ahead of anticipated tariffs on imported goods. Domestic economic contributors to GDP growth remained generally solid.¹

“An important way to measure the economy's strength is to consider the three D’s,” says Beth Ann Bovino, chief economist for U.S. Bank. “Depth, duration and dispersion.” She notes that while depth, meaning a contraction in growth, was evident, the negative numbers don’t yet exceed one quarter (duration), and the negative impacts to growth were not broad-based (dispersion).

“People are still spending, consuming and investing,” says Bovino, “but not on U.S. product”.

The influence of Trump’s tariff policy

2025’s economic expectations were turned upside down when President Donald Trump proposed significant new, broad-based tariffs on imported goods. Most notable was the implementation of tariffs of 145% imposed by the U.S. on most Chinese goods. China retaliated with 125% tariffs on U.S. goods. The Trump administration imposed 10% tariffs on most other trading partners, with higher tariffs applied to specific types of goods.

“This was spiraling into something we hadn’t seen since 1900,” says Bovino about recent U.S. tariff policy. However, following brief negotiations with China, President Trump reduced tariff levels on Chinese goods to 30%, at least for 90 days. “If we’re seeing a rapprochement from the tensions that developed between the two largest economies in the world to something more manageable, that is a good sign for the U.S. economy,” says Bovino.

Consumer spending is key to economic growth

Economic growth is primarily driven by consumer spending. In 2025’s first quarter, personal consumption expenditures rose by 1.8%, helping the economy avoid a significant setback from vigorous export activity. However, that was down from 4.0% personal consumption expenditure growth in the prior quarter.¹

Declining consumer sentiment has been a notable 2025 trend. According to surveys by the University of Michigan and the Conference Board, consumers appear to be more cautious about their future economic prospects. In May’s update from the University of Michigan, after the escalation in US-China tensions, consumer sentiment dropped again, to its second-lowest reading on record.² But after the temporary pause, Consumer Confidence improved dramatically as households are apparently hopeful that the price squeeze has lessened. Bovino recognizes that the bounce-back is positive, though notes that tensions will continue to run high until negotiations are finalized.

Bovino notes that history shows there isn’t always a strong correlation between consumer survey responses and actual consumer behavior. “What we’re seeing in consumer sentiment surveys is frustration, concerns and fear about what might happen to prices, which are already high,” says Bovino. “While households are mindful of the potential impact of higher tariffs on prices, we haven’t seen a meaningful change yet in spending behavior.”

Bovino adds that the job market's continued strength is likely to continue driving consumer activity. “If unemployment remains in the 4.0% to 4.5% range, it’s likely that consumers will remain in a strong enough position to maintain spending levels.”

Inflation moderates, but uncertainty persists

Rising inflation expectations primarily drive current consumer sentiment concerns. In 2025’s early months, inflation is trending in a positive direction. The headline Consumer Price Index (CPI) increase over the 12 months ending in April 2025 stands at 2.3%, its smallest 12-month rise in more than four years.³

To this point, tariffs have not yet moved the inflation needle. “Households are mindful that tariffs are taxes,” says Bovino. “That’s ultimately likely to lead to higher prices, even though we’ve seen the Trump administration significantly pare back tariff levels.” Bovino notes that even at reduced levels, tariffs as they stand in mid-May are still five to six times greater than what existed before President Trump’s actions.

One major retailer, Walmart, indicates that price increases on many products are likely to occur as early as May 2025.⁴ Investors will closely monitor pricing trends to gauge the potential economic impact.

A more favorable outlook

Bovino sees the Trump administration’s recent reduction of Chinese tariffs as a positive economic development. “One key factor is that the 90-day pause on extreme tariff policies comes just when businesses are placing their holiday season orders, so they may have an opportunity to stock their shelves at lower prices.” Yet a degree of uncertainty persists, as President Trump has not yet indicated that tariff levels are permanently reduced.

“If we continue to see a rapprochement from the tensions that developed between the U.S. and China into something more manageable, that’s a good sign for the U.S. economy going forward,” says Bovino. She notes that consumers are still spending, and businesses are investing, although perhaps at a more cautious pace.

“If previous tariff levels re-emerge after the 90-day pause,” says Bovino, “the recession threat is likely to rise again.”

Pursuing less restrictive tariff policies may also take some pressure off the Federal Reserve (Fed) as it sets monetary policy, according to Bovino. “If the threat of higher inflation is sidelined due to reduced tariffs, the Fed may be willing to be more accommodative with rate cuts.” That would likely result in lower borrowing costs, which could help bolster economic activity. Tariff policies will likely remain the most significant economic variable.

Implications for investors

Prior to tariff announcements on April 2, financial assets reflected solid economic growth, corporate profits, business and consumer spending and a stable labor market. International prospects also improved, with European markets exhibiting strength on shifting fiscal policy and green shoots in economic data. Post-April 2, tariff policy dominates capital market activity, with markets digesting a dramatic sequence including high tariff rates per country and a commitment to reshoring industry followed by an about face on reshoring and tariff rate stringency, with markets trading in a massive range across major categories.

Tariff news remains front and center as investors update economic growth and inflation expectations based on anticipated tariff levels. Recent equity market performance reflects falling recession odds and easier pressure on earnings growth. However, volatility may persist as investors adapt to changing prospects for tariffs and their impact on economic growth. Meanwhile, expectations for fewer Federal Reserve policy rate cuts, lingering inflation, and increasing investor’s increasing fiscal deficit focus lifted U.S. Treasury yields, hurting bond investors as prices move inversely from yields. Ten-year Treasury bond yields greater than 5.00 or 5.25% could raise investor concerns; recently, the 10-year yield has remained between 4.00 to 4.75% during most periods over the last 18 months, and recently traded near 4.55% on Thursday, May 23.

We continue to anticipate an overall positive yet non-linear event cycle from here, with all eyes on tariff negotiation progress but, more importantly, how businesses and consumers react with spending and activity. Policy timing also remains key, with investors awaiting yet-to-be implemented tax cuts, deregulatory efforts and potential interest rate cuts to provide a positive growth offset to tariffs and government spending reductions. Overall, we remain glass half-full on likely outcomes but also respect adverse possibilities.