US Q1 GDP contracts, but PCE inflation 40 bps lower

1 May 2025 , 03:45 PM

US GDP CONTRACTS IN FIRST QUARTER OF 2025

The hawkish policy of the Fed may not have caused a hard landing, but reciprocal tariffs imposed by Trump and consequent consumption slowdown have surely had an impact. For the first quarter of 2025, the first advance estimate of real GDP shows contraction of -0.3%. This is in against 2.4% real GDP grown in year 2024. The contraction in GDP was largely driven by a spike in imports and a sharp fall in government spending. However, consumer spending continued to be robust, although it must be said that this data refers to March 2025, which was before reciprocal tariffs became effective.

How did the components of GDP look like? Personal financial consumption growth fell from 4.0% in Q4-2024 to 1.8% in Q1-2025. In this period, the output of durable goods dipped from 12.4% to -3.4%, even as non-durable goods output and services output were marginally lower. With the belt tightening undertaken by Trump, there was a perceptible fall in Q1 in Federal spending, with a much sharper fall in defence spending. Trump policies have clearly brought in uncertainties for the US economy.

WHAT TRIGGERED THE FALL IN PCE INFLATION

The good news is that PCE inflation (the key input for rate action) fell sharply for March 2025. From a level of 2.7% in February, PCE inflation fell to 2.3% in March. Core inflation (excluding food and fuel) was sharply down by 40 bps to 2.6% in March 2025. Interestingly, the food inflation spiked by 50 bps to 2.0%, which can be attributed to the selective tariff impact. However, the oil supply glut in global markets resulted in fuel inflation going deeper into the negative from -1.2% to -5.0%. Overall, services inflation remains the pressure point, while durable and non-durable goods inflation has slipped into the negative in March 2025. What do the Q1 GDP data and the PCE inflation mean for the rate cut probabilities as indicated by CME Fedwatch?

CME FEDWATCH – STILL OPTIMISTIC ABOUT RATE CUTS

Falling inflation and GDP contraction have held the probability of rate cuts in the year 2025 and 2026.

Fed Meet	200-225	225-250	250-275	275-300	300-325	325-350	350-375	375-400	400-425	425-450
May-25	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.5%	95.5%
Jun-25	Nil	Nil	Nil	Nil	Nil	Nil	Nil	2.9%	63.8%	33.3%
Jul-25	Nil	Nil	Nil	Nil	Nil	Nil	3.3%	56.3%	37.8%	2.5%
Sep-25	Nil	Nil	Nil	Nil	Nil	3.1%	51.7%	39.4%	5.6%	0.2%
Oct-25	Nil	Nil	Nil	Nil	2.3%	38.9%	42.6%	14.5%	1.6%	0.1%
Dec-25	Nil	Nil	Nil	1.7%	30.1%	41.7%	21.3%	4.7%	0.4%	Nil
Jun-26	0.6%	4.6%	15.5%	27.9%	28.4%	16.6%	5.4%	0.9%	0.1%	Nil
Dec-26	1.5%	5.7%	15.2%	24.9%	25.9%	17.2%	7.3%	2.0%	0.3%	Nil

Data source: CME Fedwatch

Here is what we read from the probability table.

• By Jun-25, probability of minimum 25 bps rate cut has gone down sharply to 66.7%.
• By Dec-25, probability of minimum 100 bps rate cut has gone up sharply to 73.5%.
• By Jun-26, probability of minimum 125 bps rate cut has gone up sharply to 78.0%.
• By Dec-26, probability of minimum 125 bps rate cut is down to 73.2%.

Markets are still expecting 100 bps by end of 2025 and 125 bps by end of 2026. However, CME Fedwatch is expecting rate cuts to be back-ended in the second half of 2025.