U.S. economy contracts in Q1 2025, driven by trade war and slowing consumer spending

Consumer spending, which is a key driver of economic growth, rose at a modest pace of 1.8% in the first quarter of 2025, the smallest increase since mid-2023. The slowdown in spending is significant, as it signals that U.S. consumers are becoming more cautious amid rising prices and economic uncertainty. The federal government also reduced its spending, with the Department of Government Efficiency cutting jobs and contracts, further contributing to the economic slowdown.

Despite these challenges, some positive signs emerged from the data. Final sales to private domestic purchasers, which measure demand from businesses and consumers while excluding more volatile factors like international trade and government spending, rose by 3%. This was slightly higher than the previous quarter's 2.9% increase, indicating that domestic demand remains resilient despite the overall GDP contraction.

Trade war impact on GDP

However, the primary factor behind the contraction was the Trump administration's ongoing trade war. As businesses rushed to import goods before tariffs were implemented, net exports—the difference between imports and exports—subtracted nearly 5 percentage points from GDP. This marked the largest drag on GDP from net exports on record, dating back to 1947. The surge in imports, which grew at their fastest pace since 2020, reflects the pull-forward effect of businesses stocking up ahead of tariff changes, which had a significant negative impact on the GDP calculation.

Shannon Grein, an economist at Wells Fargo, commented, “The headline decline overstates weakness because a lot of that was tariff-induced pull-forward.” She suggested that the underlying demand was still solid, with investments in business equipment and inventories helping to counterbalance the negative impact from trade disruptions.

Uncertainty in the current quarter

As The Wall Street Journal reports, while the GDP data for the first quarter reflects the impact of tariff-related changes, it is a backward-looking indicator. Economic conditions have continued to evolve, with ongoing uncertainty over tariffs and financial market volatility affecting both consumer and business sentiment. The stock market, for instance, saw declines following the GDP release, underscoring concerns about the future trajectory of the economy.

President Trump, in a statement on Truth Social, blamed former President Joe Biden for the stock market’s decline, asserting, “This is Biden’s Stock Market, not Trump’s. I didn’t take over until January 20th.” However, Jared Bernstein, a top economic official during the Biden administration, countered these claims, pointing out that the stock market performed better under Biden than under Trump. Bernstein also noted that Trump’s tariffs had contributed to the record drag on GDP from net exports.

The continuing impact of tariffs

Trump has consistently argued that tariffs are crucial for long-term economic growth, as they would help to bring back manufacturing jobs and make America wealthier. However, the immediate impact of the tariffs has been to create uncertainty, raise prices, and disrupt supply chains. The March trade deficit in goods hit a record, as businesses sought to bring in goods before the tariffs took full effect.

A separate report from the Commerce Department showed that consumer spending in March surged, driven in part by households purchasing vehicles ahead of the anticipated tariffs. Despite this increase in spending, analysts are concerned that the long-term effects of tariffs will lead to higher prices and reduced consumer confidence.

Outlook for the economy

Mark Zandi, chief economist at Moody’s, warned that while the GDP data “probably overstates the economy’s weakness,” the overall economic outlook remains fragile. Zandi emphasized that if the administration does not find a resolution to the ongoing tariff issues, the U.S. could face even weaker economic conditions in the future, including potential job losses.

The Federal Reserve is also facing a difficult balancing act. On one hand, it needs to control inflation, which may rise due to tariffs. On the other hand, it must ensure that the labor market remains strong and that rising unemployment does not exacerbate the economic slowdown. Fed Chair Jerome Powell has acknowledged that higher tariffs could lead to both increased prices and higher unemployment, creating a "challenging scenario" for the central bank.

A strong start to 2025

Despite these challenges, the U.S. economy entered 2025 with strong fundamentals. Growth in 2024 had been steady, and inflation continued to ease. The labour market showed signs of strength, with low unemployment rates. However, the uncertainty surrounding tariffs and their potential to raise prices is likely to weigh on consumer sentiment and economic performance in the coming months.

In conclusion, the first-quarter GDP contraction highlights the significant impact that Trump’s trade policies are having on the U.S. economy. While there are signs of underlying strength, the ongoing trade war and its effect on tariffs, prices, and market sentiment present ongoing challenges for both consumers and businesses. As the situation unfolds, the economic landscape remains highly uncertain, with potentially serious consequences for future growth and employment.