US Q1 GDP STAYS IN CONTRACTION MODE
The contraction in GDP in the first quarter of 2025 is for real. The first advance estimate of US Q1GDP showed -0.3% contraction, while the second estimate shows marginally improvement at -0.2%. The moral of the story is; the contraction is for real! The fall in GDP was largely an outcome of a spike in imports, which is what the data also shows.
Economists believe this could be a one-off event as importers front-ended imports ahead of the tariffs. A lot will depend on whether and how tariffs pan out. If we were to compare the first estimate with the second estimate of US Q1GDP, the 10 bps improvement is largely due to improved investments, even as consumption has seen additional stress.
CONSUMPTION AND GOVERNMENT SPENDING FALTERS IN Q1
Interestingly, with the DOGE initiative and Trump trying to prune government costs, even government spending contracted in the first quarter. The goal of lower imports and a lower trade deficit has, perhaps, been partially achieved, but this has been achieved at the cost of contraction in GDP. The question is; whether it was worth it?
This is the first negative quarter for US real GDP, since Q1-2022. Back then, the real GDP was hit by a sharp spike in inflation. In Q1-2025, real GDP is in negative zone despite very low levels of inflation; which is an area of concern. For Q1-2025, non-durable goods grew at 2.2% and services at 1.7%. However, durable goods GDP put pressure, contracting -3.8%.
PCE INFLATION FALLS 60 BPS IN TWO MONTHS
The personal consumption expenditure (PCE) inflation is announced towards the end of the month, unlike CPI inflation that is announced in the middle of the month. The Fed uses PCE inflation as the benchmark for deciding on rate action. PCE inflation looks at inflation from the perspective of personal financial consumption. Thus, it factors in prices and spending habits; making it more reliable as an indicator for Fed policy.
When reciprocal tariffs were announced by Trump, there were concerns that higher import tariffs would escalate inflation in the US. After all, the US economy runs a large trade deficit. However, in reality, the US government put reciprocal tariffs on hold for 90 days and in the last 2 months, the PCE inflation has fallen by 60 bps from 2.7% in Feb-25 to 2.1% in Apr-25.
WHAT PULLED DOWN PCE INFLATION TO 2.1% IN APRIL 2025?
If one looks at the break-up of PCE inflation in April, it was driven by direction of consumer spending. For instance, consumer spending is higher in services like housing, healthcare, food services, accommodation, and transport. Goods saw contraction in consumption spending due to lower spending on food & beverages, clothing & footwear, motor vehicles, and recreational goods. Financial services was one of the few services contracting in April.
What explains the 50 bps fall in PCE inflation in last 2 months. Core inflation fell from 2.9% to 2.5% in this period, while food inflation moved higher from 1.5% to 1.9% in this period. However, the biggest trigger for the fall in PCE inflation in last 2 months has come from the Energy basket, which has moved from -1.2% in February 2025 to -5.5% in April 2025. Weak crude prices is making all the difference.
CME FEDWATCH – STICKS TO 2 RATE CUTS IN 2025
Ideally, lower PCE inflation and weak GDP should have raised the probability of rate cuts, but that has not been the case. Here is a quick dekko.
Fed Meet | 200-225 | 225-250 | 250-275 | 275-300 | 300-325 | 325-350 | 350-375 | 375-400 | 400-425 | 425-450 |
Jun-25 | Nil | Nil | Nil | Nil | Nil | Nil | Nil | Nil | 2.2% | 97.8% |
Jul-25 | Nil | Nil | Nil | Nil | Nil | Nil | Nil | 0.5% | 22.0% | 77.6% |
Sep-25 | Nil | Nil | Nil | Nil | Nil | Nil | 0.3% | 14.3% | 57.8% | 27.6% |
Oct-25 | Nil | Nil | Nil | Nil | Nil | 0.2% | 8.1% | 38.5% | 41.0% | 12.3% |
Dec-25 | Nil | Nil | Nil | Nil | 0.1% | 5.7% | 29.4% | 40.3% | 20.8% | 3.7% |
Jun-26 | Nil | 0.1% | 1.4% | 6.8% | 17.9% | 27.9% | 26.4% | 14.6% | 4.4% | 0.5% |
Dec-26 | 0.3% | 1.5% | 5.5% | 13.6% | 22.6% | 25.5% | 19.1% | 9.1% | 2.5% | 0.3% |
Data source: CME Fedwatch
Here is what we read from the probability table.
Jerome Powell of the Fed has underlined time and again (including in the latest FOMC minutes) that the disruptive impact of tariffs could be very high. Hence, the Fed needs to keep weapons in its arsenal to fight inflation, should it spike post-tariffs. The most likely scenario at this juncture is an additional 50 bps rate cut by end of 2025 and another 25 bps rate cut by end of 2026.
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