Post from First Trust Economics Blog

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist 

June 2nd, 2025

Conventional wisdom was that the tariffs imposed by the

Trump Administration would cause higher inflation and slower

growth – stagflation as far as the eye could see. But this past

week brought economic news that defied this prediction.

The trade deficit plummeted in April, signaling that

economic growth could surge in the second quarter. The Atlanta

Fed GDPNow model has Q2 at a +3.8% for now. Inflation also

slowed sharply with the Federal Reserve’s preferred measure of

inflation now up only 2.1% on a year-ago comparison basis, just

a hair above the official target of 2.0%.

Investors can be forgiven for being confused. After real

GDP declined at a 0.2% annual rate in the first quarter, many

(especially those opposed to Trump) thought this dip was a

harbinger of recession, with more declining real GDP ahead.

But, as we said at the time, the decline in Q1 real GDP was

largely due to an unprecedented surge in imports (front-running

tariffs), and that would reverse in Q2 and beyond. At this point,

it looks like this is happening now.

We like to focus on “Core GDP” which is real GDP

excluding government purchases, inventories, and international

trade, each of which is volatile from quarter to quarter. Core

GDP grew at a 2.5% annual rate in Q1, faster than the average

annual rate of 2.2% in the past twenty years.

Imagine a store that sells furniture manufactured in both the

US and abroad. Once President Trump was elected and seemed

intent on eventually raising tariffs, it made sense for that store to

“front-run” the tariffs by temporarily increasing orders from

foreign suppliers while temporarily reducing orders from US

suppliers. Even if sales (consumption) did not change, the

accelerated imports were subtracted from GDP, which is what

caused the decline in real GDP in Q1.

With Friday’s advance report on international trade in April

signaling the largest drop in the trade deficit for any month in

modern US economic history, that process is reversing. But even

if growth comes in at 3.8%, or better, don’t be confused.

The economy was not in massive trouble in Q1, and it is not

booming in Q2. Now that some of the threatened tariffs have

finally taken effect, firms selling goods in the US are back to

ordering more from their domestic suppliers.

In the meantime, the fact that inflation continues to decline

really shouldn’t surprise anyone. The M2 money supply is

basically flat since 2022. Yes, tariffs can mean the items being

tariffed cost more. But inflation is ultimately a monetary

phenomenon, and tariffs don’t change monetary policy. So, if

the tariffed goods cost more, that means less money is leftover to

buy other goods and services, putting downward pressure on

those other items. Net, net, M2 growth says low inflation.

Inflation data show a quiet past three months, with PCE

prices up a mere 0.1% in April. They are now up only 2.1% from

a year ago, a much slower increase versus last year.

None of this means we are out of the woods on recession

risk or that the inflation dragon has been slain. If the Fed were

to dramatically loosen monetary policy, inflation could come

back quickly. What it does mean is that investors need to be wary

of getting caught up in news about the economy that often has a

partisan political angle.