Economic Update: May 19, 2025

Growth

The U.S. economy slowed more than expected in 1Q, with real GDP dropping 0.3% annualized. Consumer spending rose modestly at 1.8%, with goods up 0.5% and services up 2.4%. Private investment surged 21.9% due to inventory spikes before tariffs, while government spending fell 1.4% due to reduced federal spending. Net exports dragged growth by 4.8% due to a 41% import increase. The economy may be closer to recession than expected, strengthening the case for the Federal Reserve to cut rates sooner rather than later.

Jobs

The April Jobs report was relatively muted, indicating the labor market is still in good condition. Nonfarm payrolls increased by 177k, exceeding expectations, while prior months were revised down by 58k, raising the three-month average to 155k. Services led private payroll gains, with health care at the forefront, while manufacturing employment was unchanged. Government payrolls increased but were weighed down by a decline in federal payrolls. The unemployment rate remained at 4.2%, and wages rose 0.2% m/m and 3.8% y/y. With a solid report, the Fed should have enough confidence in the health of the labor market for now.

Profits

The 1Q25 earnings season is wrapping up with 88% of market cap reporting. Currently, consensus is projecting pro forma EPS of $64.01. If realized, this estimate would represent y/y growth of 13.4% and q/q growth of -2.7%. Looking at the three main sources of EPS growth, sales, margins and shares are expected to contribute 5.2, 9.2 and -1.1 percentage points, respectively, to y/y growth. So far, 77% of companies have beaten estimates, and earnings have come in 10.3% above consensus, driven by strong beats from the Mag 7. Technology is again contributing the majority of EPS growth, followed by health care on weak comparisons. Energy and materials are still struggling through weak oil prices and muted demand from China. While results have been solid, management teams are concerned about tariffs and discussing plans for cost cutting and price increases.

Inflation

The April CPI report came in softer than expected, suggesting that businesses have been slow to pass on tariff-related costs to consumers. Headline CPI rose 0.2% m/m and 2.3% y/y, while core CPI rose 0.2% m/m and 2.8% y/y. Core goods were up just 0.1% as apparel and autos were unexpectedly weak. That said, tariff impacts were apparent in some products, such as appliances and photo equipment, although these have low weights in the index. Elsewhere, shelter increased 0.3% m/m while core services ex. shelter rose 0.2%. This softer report, coupled with recent trade deal news, is certainly welcome. However, even if the 10% baseline tariff is all that stands after the dust settles, inflation could still bounce to 4% by year-end.

Rates

• At its May meeting, the FOMC voted to leave the federal funds rate unchanged at 4.25%-4.50% for a third consecutive meeting. Despite some signs of policy-induced weakness, the Fed remains committed to its “wait-and-see” approach and is in no hurry to make meaningful adjustments to policy until the ultimate form and impact of tariff policies become clearer. The committee still views economic activity as solid, attributing the negative 1Q25 GDP print to distortions from a spike in imports. The most notable changes to the FOMC statement were a recognition that the risks of both higher inflation and higher unemployment have risen. With elevated uncertainty and risks to both sides of their mandate, the Fed will be slow to bring rates down, and their pace will continue to hinge on incoming economic data.

Risks

• Tariffs could challenge economic growth while putting upward pressure on inflation.
• Market volatility will likely remain elevated until policy uncertainty turns to policy clarity.
• Slowing economic growth could weigh on earnings and forward guidance.

Investment Themes

• Fixed income offers attractive levels of income and protection against an economic downturn.
• The ongoing equity market rotation should present opportunities in sectors outside of tech.
• Higher government spending in Europe and China should support better international performance.

This weekly update provides a snapshot of changes in the economy and markets and their implications for investors.

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Originally Posted May 19, 2025 – Economic Update

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