"Q1 2025 - The Pre-Order Party"

GROSS DOMESTIC PRODUCT

• Aggregate GDP contracted at a modest pace of -0.30% in Q1 2025, marking the first contractionary quarter of economic growth since Q1 of 2022. While aggregate GDP contracted in the quarter, paradoxically, the two largest components of GDP (Consumer Spending & Private Investment) both grew in the quarter. In fact, this combination is so rare that is has only happened 3 times in the United States since 1959. The vast majority of contractionary effects in Q1 2025 primarily came from a surge in imports ahead of tariff anncouncements^1,2
  • Consumption
    • The Consumer Spending component of GDP grew at a pace of 1.8% in Q1 2025, down from the abnormally high rate of 4.0% in the prior quarter. Personal Consumption has been positive every quarter since Q2 2020. Spending growth on Goods and Services were both positive, coming in at rates of 0.5% and 2.4% respectively. Within Goods spending, Durable Goods experienced a contraction of -3.4% – which appears to have come from a contraction in Automobile spending relative to the prior quarter. Non-Durable goods spending experienced growth of 2.7% which was relatively balanced across its subcategories. Consumer spending of Services continued to grew at a solid pace of 2.4% in the quarter. Noteworthy areas of spending within Services included Healthcare at 4.1%, Transportation Services at 5.3%, and Housing & Utilities at 3.4%. ^1,2
  • Investment
    • The Private Investment component of GDP grew at an abnormally high rate of 21.9% in Q1 2025. This was the highest rate of growth recorded for this category since Q4 of 2021. Within Private Investment, Non-Residential investment grew at a pace of 9.8% which was bolstered by Computer Equipment growth of 112.8% in the quarter. Residential investment grew at a pace of 1.2% in Q1, and saw mixed growth in Single and Multi-Family housing. Single family housing investment grew at a pace of 5.9%, while Multi-Family housing contracted at a pace of -11.5% – it’s 7^th consecutive quarter of contractionary spending. Private Inventories were augmented by a substantial amount in the period, having grew by 140.1B – the highest rate of Inventory augmentation since Q1 of 2022. The majority of the inventory additions appear to have occurred from Wholesale Trade businesses, which added 111B out of the 140.1B figure^1,2
  • Net Exports
    • Net Exports were the primary culprit behind the contractionary aggregate GDP growth figure in Q1 2025. Net Exports contracted to a level of -1.37T – by far the largest Trade Deficit ever recorded in U.S. history (prior was -1.13T in Q1 of 2022). The United States’ Exports actually increased over this time at a pace of 1.8%, however this was entirely overshadowed by the historic increase in Imports in the quarter of 41%. When looking into the composition of the increase in Imports it appears that the majority came from Imports of Consumer Goods – which climbed by 141.5% in the quarter as businesses rushed to ‘front-run’ the implementation of worldwide reciprocal tariffs.  ^1,2
  • Government
    • Government spending contracted in Q1, coming in at a pace of -1.4%. The decrease was driven by lower Federal Government spending which dropped by -5.1%. Federal Government ‘right-sizing’ efforts appear to have reduced spending across all major sub-categories (Defense and Non-Defense) which dropped by -8.0% and -1.0% respectively. State and Local Government spending stagnated in the quarter, coming in at a pace of just 0.80%. Overall, the drop in Government spending was only a very minor contributor to overall GDP contracting in the quarter. ^1,2

EMPLOYMENT

• The Unemployment Rate for the U.S. Economy held in April and now stands at a level of 4.2%, up from the recent low mark of 3.7% in December 2023. Upticks in the Unemployment Rate have been mostly driven by a lower rate of growth in the Labor Force relative to growth in Unemployed Persons^1,3

• Regarding the Labor Force, we have seen a steady increase in the metric over the past few years and are now at an all-time high level of 171.1M^1,3
  • Higher levels of wage growth are an important factor driving growth in the Labor Force over the past year^1,3
  • The Labor Force Participation Rate remains below pre-pandemic levels and is now at 62.6%. Pre-Pandemic levels were roughly closer to 63%^1,3

• Within the Household Survey, the number of Employed Individuals has remained steady over the past quarter. The number of Employed Individuals rose to a level of 163.9M after previously being rangebound around the 161M level in 2024^1,3

• A key metric monitored by the Federal Reserve, Job Openings, have moderated significantly over the past 2 years, which is largely seen as a positive sign from the Fed that the Labor Market is back in better balance. Job Openings are down to 7.19M from the all-time high mark of 12.18M achieved in 2022^1,3
  • There are now 0.99 Job Openings available for every unemployed person^1,3
  • The number of Unemployed Persons currently stands at a level of 7.2M, an uptick from 6.1M seen at the start of 2024^1,3
  • Regarding the Labor Market’s effect on overall Inflationary Pressures, the Fed now officially no longer sees an abnormally unbalanced Labor Market as being a contributor to inflationary pressures^1,3
    • (Federal Reserve) “With regard to the outlook for the labor market, participants noted that further cooling did not appear to be needed to help bring inflation back to 2 percent”^1,3

• Average Weekly Earnings are up 3.9% over the past year^,3
  • Over the past year, Average Weekly Earnings increases have been entirely attributed to increases in Wage Growth as opposed to Hours Worked^1,3
  • Elevated Wage Growth, in tandem with consumer substitution effects, have been instrumental factors in allowing U.S. consumers to partially offset the effects of higher Inflation^1,3

INFLATION

• Headline PCE Inflation contracted in the month of march at an annualized rate of -0.50%. This marked the first month since May 2024 where the economy experienced an overall level of deflation^1,4
  • Core PCE Inflation rose in the month of March at a pace of just 0.30% – the lowest monthly increase since 2020^1,4
  • The month of March represented a return to more normalized levels of inflation relative to the prior two months’ readings which were above average^1,4

 

• Material differences continue to persist between Goods Inflation and Services Inflation^1,4
  • Goods prices dropped by a rather large degree in March, experiencing deflationary effects of -5.6%.^,1,4
    • Durable Goods dropped by -0.6% in the month, which was driven by decreases in Motor Vehicles & Parts of about -4.5% ^1,4
    • Non-Durable Goods also dropped in the month of March at a pace of -8.2%. The large drop in prices of Non-Durable Goods was driven by a bid drop in Gasoline prices of -51.8%. Additionally, deflationary effects were seen across Household Supplies of -7.5%, and Pharmaceuticals of -18.5% ^1,4
  • Services Inflation has largely been the area of the economy exhibiting the more robust and persistent inflationary pressures over the past year. In the month of March, Services Inflation actually dropped to a level of just 1.9% – the lowest reading for the category since November of 2020 ^1,4
    • Within the Services category, there are a few sub-categories that standout as being noteworthy. Transportation Services dropped by -7.5%. Healthcare costs dropped by -1.2%. Electricity and Gas utilities experienced a large uptick of 19.2% in March. Rent price remain stubborn, coming in at a pace of 4.1%. Hotel and Motel accommodations experienced a large contractionary month, coming in at -41.3%^1,4

 

• Market Expectations of future inflation levels have been extremely stable since the mid-point of 2022, a potentially welcome sign for the economy as expectations of future inflation have historically been closely correlated with actual inflation to come^5,6
  • Market Expectations for future Inflation on a 5yr forward looking basis have been rangebound between 2.0% and 2.5% since 2022. Q1 did see a downtick in the market’s expectations of 5yr inflation, dropping from the 2.5% all the way to 2.2%^5,6
  • Market Expectations for future Inflation on a 10yr forward looking basis have also been rangebound between 2.0% and 2.5% since 2022. The same downward trend in forward looking expectations exhibited in Q1 for 5yr inflation was also mirrored in the 10yr inflation metric^5,6

 

FORWARD LOOKING ASSESSMENT

Well, that was strange.

Prior to looking at any data, if you would have told me that the largest two components of GDP (Personal Consumption & Private Investment), which account for 88% of the economy, would both experience solid growth in the quarter – but that the quarter would still be contractionary… well I’d be skeptical to say the least.

Nevertheless, that is exactly what we got (I double checked). In fact, it’s such a rare occurrence for this to happen that this is only the 3^rd time it’s ever happened since 1959. So why is it that something so rare, and misleading, is happening currently? Well, as most economic headlines these days usually lead back to – tariffs. But maybe not in the way that you think…

It was really no secret to Wall Street that the Trump Administration’s second term in office would place a large degree of emphasis on international trade via the use of tariffs as a negotiating tool. Once the election results were in, companies who majorly source items from overseas ramped up their purchasing of goods in an effort to ‘get ahead of those incoming penalties. Of course, nobody actually knew what the tariff proposals would ultimately be at the time, however they did know that it was more likely than not that tariffs (in some form and magnitude) were coming. Rather than sit around and wait, companies ordered A LOT in advance… and I mean A LOT. Just to put it into perspective, from Q4 2024 to Q1 2025 U.S. imports of goods rose by 323B – the second highest quarterly increase ever, with the only other higher reading coming during the pandemic disruption era. So, from a quantitative perspective… yes, it was abnormal.

The way economic reporting of GDP works is that the U.S. ‘gets credit’ for things it exports to other countries but is ‘penalized’ when it imports things in from other countries – this is because money is flowing out of the economy and into other economies. That penalty for importing things into the U.S. was so high in the period that it more than overwhelmed the positive growth factors from the increase in consumer spending and increase in private investment. The question then remains, is this instance of super-high importing here to stay? Not likely.

One way to think about this quarter’s abnormal uptick in imports could be a type ‘last hoorah’ situation. With tariffs at current levels, and even still higher than what companies are used to post-negotiations, it will become a business necessity to adjust supply chains in a way that allows firms to remain cost-competitive. Some may elect to onshore their sourcing of goods and materials back into the U.S., and some may elect to source from lower tariff countries. At any rate, due to the current need for supply chain evolution, the U.S.’s aggregate imports are likely to trend in a downward direction over the next few years. From a quantitative perspective, the U.S. may have needed one last big quarter of imports to ‘tide us over’ while supply chains get reconfigured in exchange for systematically lower imports in the future (thereby benefiting U.S. GDP growth).

Another aspect of the supply-chain shifts taking place that is somewhat overlooked is how ‘valuable’ of a thing it is to be host to American company manufacturing efforts. It is the very thing that brought China’s economy into the modern era over the past few decades. Foreign countries undoubtably see that and are most likely going to be putting their best foot forward to entice American companies to on-shore their manufacturing operations on their soil. Therefore, American companies looking to switch-up their supply chains may find it easier than initially anticipated to find a new home for their efforts. Plenty of countries out there would love to ‘be the next China’, and as well all know, competition breeds innovation – and potentially deals along with it.

Will these supply-chain shifts be immediate? No, probably not. However, most worthwhile investment endeavors take time – moreover, just because something takes time to payoff does not mean it isn’t an immediate business necessity at present time to initiate. Overall, the U.S. economy is a complex thing, with more moving parts than what anyone can account for. As we move forward into the next few quarters, we will without a doubt continue to see more and more of this story play out, but as it does there is without question numerous incentives all over the place to reward companies (and customers) to ‘figure it out’. Where there is an incentive, there is a will – and (as we know) where there is a will there is a way.

[See Below for Disclosures & Annotations]

DISCLOSURES

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The companies presented here are for illustrative purposes only and are not to be viewed as an investment recommendation.

Tax laws and regulations are complex and subject to change, which can materially impact investment results. LPL Financial does not provide tax advice. Clients should consult with their personal tax advisors regarding the tax consequences of investing.

 

ANNOTATIONS

1. FactSet. “Economics – Country/Region – United States”. May 2, 2025
2. Bureau of Economic Analysis. “Gross Domestic Product, 1st Quarter and Year 2025 (Advance Estimate)”. May 2, 2025.
3. Bureau of Economic Analysis. “Labor Force Statistics from the Current Population Survey”. May 2, 2024.
4. Bureau of Economic Analysis. “Personal Income”. May 2, 2025.
5. FRED. “5-Year Breakeven Inflation Rate”. May 2, 2025.
6. FRED. “10-Year Breakeven Inflation Rate”. May 2, 2025.