Economic Update: A Review of First Quarter 2025

The stock market experienced a volatile first quarter with volatility continuing through early April as well. Supply chain disruptions, deteriorating consumer sentiment and changing monetary policy all contributed to uncertainty during the last half of the first quarter. This uncertainty was further heightened with the recent announcement of sweeping tariffs by the Trump administration on April 2. 

At this point, it is still unclear whether the April 2 announcement represents a dramatic change in U.S. long-term policy or merely the starting point for further negotiations. Regardless, global markets have reacted violently to the shift in policy so far.

U.S. Economy

U.S. GDP grew at an annualized rate of 2.3% during the fourth quarter 2024, but there is a wide dispersion of estimates for what we will see for the first quarter 2025. As of this writing, at the low end the Atlanta Fed GDPNow model predicts a 2.8% contraction, although that model may be distorted due to temporarily increasing trade deficits as importers were likely attempting to front-run impending tariffs.

The CNBC Rapid Update is perhaps a better estimate as it is based on a survey of 14 economists. On average, that group expects 0.3% growth during the first quarter 2025. There is general pessimism for the rest of the year as well. For instance, JP Morgan predicts a 60% chance of recession sometime this year. Polymarket, which is an American cryptocurrency-based prediction market where investors can place bets on various future events, shows similar odds. However, note that many forecasters also predicted a recession last year that didn’t materialize. 

Unfortunately, despite these concerns about sluggish economic growth, inflation continues to be stubborn. The Consumer Price Index has fluctuated over the last few months, but the trailing 12-month rate now sits at 2.8% according to the last release for February from the Bureau of Labor Statistics. That is still more than the Federal Reserve long-term inflation target of 2%. 

Inflation has made it difficult for the Fed to continue to cut rates. As a result, it has kept rates stable since voting to lower interest rates by 25 basis points last December, so the target range remains at 4.25% to 4.5%. It is unclear how recent tariff announcements will affect future Fed decisions. If the U.S. economy does tip into recession, there potentially would be an argument for cuts to resume. On the other hand, the Fed will likely remain cautious if the inflation rate is still higher than the long-term target of 2%. As of this writing, CBOE futures markets are anticipating three to four total cuts during 2025.   

Consumer sentiment has declined significantly over the last few months. The University of Michigan's Index of Consumer Sentiment dropped to 57.9 in March 2025, down from 64.7 in February and 79.4 a year ago. The index is now at its lowest point since 2022. Consumers across all demographics including age, education, income, wealth, political affiliations and geographic regions reported declining sentiment, which could affect future spending behavior.

On a positive note, the U.S. labor market showed resilience in March 2025, with employers adding 228,000 jobs during the period. This figure significantly exceeded economists' expectations of 130,000 jobs and occurred despite headlines of significant government employee job loss during that time. Treasury Secretary Scott Bessent emphasized the need for a period of transition to address overreliance on government spending, and the private sector appears to have helped that transition so far.

International Economy

As of this writing, tariffs range from 10% to 50% on imports from various countries. This has already sparked strong reactions globally, with initial significant declines in stock markets throughout the world. Many countries depend on exports to the U.S. as a significant contributor to their economy.

Our trading partners are understandably upset, but there are generally not a lot of good options for a response. Counter-tariffs run the risk of exacerbating inflation, which has only recently moderated. According to Trading Economics, the global headline inflation rate currently averaged 3.1% in February 2025, far lower than its peak of 8.7% during 2022.

Overall, the recent tariffs are poised to create significant challenges for the international economy, affecting everything from market stability to trade relations and inflation. Policymakers will need to navigate these complexities carefully to mitigate potential negative implications.

Markets

The U.S. stock market diverged from most of the rest of the world during the first quarter 2025. U.S. large-cap equities, as represented by the S&P 500 Index, lost 4.27% during the quarter. On the other hand, developed international equity markets, as represented by the MSCI EAFE Index, were up 6.86% for the quarter. The MSCI Emerging Markets Index also posted positive performance, finishing the quarter with gains of 2.93%.

Bond indexes had a strong start to the year, as the prospects for additional Fed rate cuts become more likely. The Barclays U.S. Aggregate Bond Index was up 2.78% during the first quarter. The Barclays Hedged Global Aggregate Bond Index was up 1.17%. With inflation being more persistent than expected, the Barclays U.S. Inflation-Linked Bond Index was also up 4.17% during the period.

Continued inflation also allowed commodities to thrive. The Bloomberg Commodity Index gained a robust 8.88% during the first quarter 2025. The Wilshire REIT Index also posted gains of 1.01% during the quarter.

Outlook  

The first quarter 2025 demonstrated the value of holding diversified assets. The U.S. stock market has been so strong over the last few years that it is tempting for investors to steer an outsized portion of their investments into sectors that have been performing well. This is particularly true for U.S. Large Cap Growth stocks including the Magnificent 7 (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla). That group of stocks has taken a significant hit so far this year.

Likewise, fixed income has been a poor performer over the last five years, as a rising interest rate environment made it virtually impossible for bonds to earn returns. However, assuming we are now in a flat to declining interest rate environment, we expect that bonds should perform much better.

However, even in times of volatility like this one, we do not advocate running away from U.S. stocks entirely. As always, we recommend a diversified portfolio containing a reasonable amount of equity exposure for any investor with a long enough time horizon.