Devil is in the details Devil is in the details http://www.federatedhermes.com/us/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedhermes.com/us/daf\images\insights\article\alligator-in-swamp-small.jpg May 6 2025 May 6 2025

Devil is in the details

Import surge pushes first-quarter GDP into the red.
Published May 6 2025
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Gross Domestic Product (GDP) slipped into the red for the first time since the first quarter of 2022, contracting 0.3% on a quarter-over-quarter (q/q) annualized pace, which was just below the Bloomberg consensus estimate of a 0.2% decline. But sequential growth slowed sharply from 2.4% in last year’s fourth quarter.

Our estimate here at Federated Hermes was for 0.9% growth, and the Blue-Chip consensus was at 0.5% growth (within a very wide range of a 0.5% decline to growth of 1.4%). The Atlanta Fed’s “GDPNow” estimate was looking for a decline of 2.7%, but their gold-adjusted estimate was expecting a smaller decline of 1.5%. In sharp contrast, the New York Federal Reserve’s “Nowcast” was expecting growth of 2.9%. 

What happened? Underlying economic growth was solid in the first quarter, with personal consumption, corporate spending and housing all stronger than expected. As a result, private domestic final sales grew 3.0% in the first quarter versus 2.9% in last year’s fourth quarter. So, how did we end up with a negative print for the first time in three years? In anticipation of President Trump’s tariff war on April 2, imports surged by more than 41% in the first quarter, which subtracted more than 5 percentage points from quarterly GDP growth. Businesses and consumers were trying to stockpile goods from overseas ahead of potentially massive price increases. This first-quarter damage from net trade was the most on record dating back to 1947, according to the Bureau of Economic Analysis. Not all these imports were consumed in the first quarter, so inventory accumulation soared by $140 billion, compared with a paltry $8.9 billion in the fourth quarter of 2024. That boosted first-quarter GDP by 2.25 percentage points, which helped to ameliorate some of the outsized damage from imports. Finally, federal government spending (particularly defense) declined by 5.1% in the first quarter, which trimmed growth by 0.33 percentage points.

Private domestic final sales in the first quarter are solid This metric gauges the underlying fundamental strength of the economy, focusing on the three core elements of GDP growth, which include personal consumption, corporate spending, and residential construction. By design, it excludes volatile inventory liquidation or restocking, net trade and government spending. In the first quarter, it grew a solid 3.0% q/q, up slightly from a 2.9% increase in the fourth quarter. Despite breathless media protestations to the contrary, this implies that a recession is not imminent. First-quarter growth was much stronger than the headline GDP decline, given the negative knee-jerk import reaction to the ham-handed implementation of Trump’s tariff polices. If the administration can neutralize this tariff noise through successful reciprocal negotiations with our major trading partners—or simply roll back the policies—we could potentially reverse last quarter’s unprecedented surge in imports. But the timing and trajectory of such corrective steps are highly uncertain.

Inflation continues to decline The core Personal Consumption Expenditure (PCE) index (the Federal Reserve’s preferred measure of inflation) rose by a nine-month low of 2.6% year-over-year (y/y) in March, down from 3.0% in February. On a month-over-month basis, core PCE inflation was flat in March, which is a five-year low, down from a 0.5% gain in February.

Fed will likely take a wait-and-see approach In its most recent Summary of Economic Projections in March, the Fed estimated that core PCE inflation will continue to gradually decline to its long-run target of 2.0% by the end of 2027. But with Trump’s tariffs, the Fed is concerned about the stagflationary potential for slower economic growth and rising inflation and unemployment. That’s not showing up in the hard economic data just yet, so we do not expect a change in interest rates at the FOMC meeting on May 7. In fact, Fed Chair Jerome Powell has cautioned that policymakers are likely to adopt a patient, data-dependent approach to future rate adjustments. We at Federated Hermes are projecting two or three quarter-point rate cuts later this year, starting in June or July.

Here are the details in the first-quarter GDP report:

  • Personal consumption (which accounts for nearly 70% of GDP on a chained-dollar basis) rose by a stronger-than-expected 1.8% q/q in the first quarter (contributing 1.21 percentage points to the gain in overall GDP), higher than the expected consensus increase of 1.2%. That compares with a 4.0% gain in the fourth quarter of last year. Retail sales were dreadful in January, declining by 0.9% month-over-month (m/m), the largest drop in nearly two years. Brutal winter weather, the California wildfires, a consumer hangover from a strong Christmas season and the smallest Social Security inflation adjustment in four years contributed to January’s weakness. But February rebounded with a marginally positive 0.2% m/m increase, and March surged by a two-year high of 1.4% m/m. We believe that consumers were motivated to front run the potential imposition of tariffs, and auto sales, for example, soared by 11% m/m in March, to a four-year high of 17.8 million annualized units. 
  • Corporate nonresidential capital spending surged by a three-year high of 9.8% in the first quarter (which added 1.29 percentage points to overall GDP growth), versus a 3.0% decline in the fourth quarter. Structures were positive for the second consecutive quarter, rising modestly by 0.4% in the first quarter, compared with a fourth-quarter gain of 2.9%. Equipment spending soared by 22.5% in the first quarter (adding 1.06 percentage points to overall GDP), reversing an 8.7% q/q decline in the fourth quarter. This strength may have been tariff-related, as well, and may not be sustainable. Intellectual property grew by a steady 4.1% in the first quarter, up from a 0.5% decline in the fourth quarter, which was this metric’s first negative quarter after 15 consecutive positive quarters.
  • Residential construction rose for the second consecutive quarter, increasing by a modest 1.3% q/q in the first quarter, which added 0.05 percentage points to overall GDP growth. Housing rose by 5.5% in last year’s fourth quarter and has been positive in five of the past seven quarters. But this recent positive trend may not be sustainable, depending upon what happens with mortgage rates in coming quarters. Existing homeowners seem reluctant to surrender their low mortgage rates, so inventory levels are relatively slim. 
  • Net trade was clearly the story in the first quarter, declining by $1.374 trillion, which gutted 4.83 percentage points from growth. Businesses and consumers were so frightened by the prospect of huge tariff increases that they significantly increased their imports to beat sharp potential price increases. As a result, imports surged by a record 41.3% q/q in the first quarter (which subtracted a massive 5.03 percentage points from GDP growth), compared with an import decline of 1.9% in the fourth quarter (which had added 0.27 percentage points to GDP growth). Exports, on the other hand, rose by a modest 1.8% q/q in the first quarter (which added 0.19 percentage points to GDP), compared with a negligible 0.2% decline in the fourth quarter.
  • Inventories soared by $140.1 billion in the first quarter as that tsunami of imports was not fully consumed, up sharply from a modest $8.9 billion increase in the fourth quarter. In contrast, inventories grew at a more moderate pace of $57.9 billion in last year’s third quarter and $71.7 billion in the second quarter. This significant sequential increase in the pace of inventory restocking added 2.25 percentage points to overall economic growth in the first quarter.
  • Government spending declined for the first time since the second quarter of 2022, falling by1.4% q/q in the first quarter, down from a 3.1% increase in last year’s fourth quarter, which subtracted 0.25 percentage points from overall growth. Federal spending dropped by 5.1% q/q in the first quarter, paced by an 8.0% decline in national defense spending, which subtracted 0.31 percentage points from economic growth. State and local spending rose by 0.8% in the first quarter, compared with a 2.5% fourth-quarter increase, which added 0.08 percentage points to growth. 

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Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

The Personal Consumption Expenditure Index: A measure of consumer inflation at the retail level that takes into account changes in consumption patterns due to price changes.

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