Post from First Trust Economics Blog

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

May 5th, 2025

Noise about tariffs, business uncertainty, a constitutional

fight, and a drop in stock prices had already created fear of a

recession. When real GDP declined in the first quarter of 2025,

some started to question if a recession is already here. Let’s take

a deep breath and consider the facts.

Yes, real GDP dipped at a -0.3% annual rate in Q1, the first

decline for any quarter since 2022. But the main reason was that

trade with other countries accounted for the largest drag on the

economy for any quarter since at least 1947, as both consumers

and companies loaded up on goods from abroad before higher

tariffs kicked in. Since GDP is designed to measure domestic

production, imports are subtracted even though Americans buy

them because they were produced abroad. We aren’t saying GDP

is a flawed statistic, we are saying it needs to be viewed correctly.

Real (inflation-adjusted) consumer spending increased at a

moderate 1.8% annual rate in the first quarter and real business

investment in equipment spiked up at a 22.5% annual rate,

neither of which looks recessionary. We like to track “core”

GDP, which is consumer spending, business fixed investment,

and home building, but excludes the most volatile categories like

government purchases, inventories, and international trade. Core

GDP grew at a 3.0% annual rate in Q1, exactly matching the

growth rate of the past year.

So, GDP was not the signal that the headline number

suggested. In fact, when it was released, initially stocks went

down only to recover as calmer heads prevailed. Nonfarm

payrolls rose 177,000 last month and are up 144,000 per month

so far this year. And the mix of jobs is much more positive. In

2023-24, 73% of the increase in payrolls were government,

education, health care, and social services jobs. These jobs are

largely driven by government spending policies, especially

deficit spending. In the past three months, that share has dropped

to slightly less than half. In other words, less of the recent job

growth is due to government spending expansion.

Another signal that the US wasn’t in recession in the first

quarter was that industrial production was up at a 5.4% annual

rate while manufacturing rose at a 5.1% annual rate.

Instead, the slippage in real GDP reminds us of the decline

in early 2022, when many analysts and investors (as well as

conservative political commentators) were quick to declare a

recession even though the decline in GDP, like in Q1 this year,

was driven by one-off factors like inventories and trade, while

the job market and industrial production kept growing.

Nonetheless, while we don’t think the data show a recession

yet, the odds of a recession starting in the next year or so are still

higher than normal. We estimate in the range of 40 – 50%. Why

is the recession risk higher than normal? For one thing, we have

yet to fully feel the effects of the tightening of monetary policy

in 2022-23 – with both a drop in the M2 measure of the money

supply as well as higher short-term interest rates.

At the same time, federal budget hawks have taken over. In

both 2023 and 2024, we saw the most reckless spending of our

lifetimes, with the budget deficit running in the range of 6.0 –

6.5% of GDP even as the unemployment rate hovered near 4.0%.

To put this in perspective, the highest deficit under President

Regan was 5.9% of GDP when the unemployment rate was

10.0%. The reckless deficit expansion of the past two years

likely masked or hid some of the pain we were eventually going

to feel from the tightening of monetary policy.

But now fiscal policy is going in reverse, with the potential

to unmask or reveal that pain. Tariffs are going up, meaning

higher receipts, while the part of the federal budget that

presidents have the most power to control – non-defense

discretionary spending – is being curtailed, including at USAID,

the Department of Education, and elsewhere. This past week the

Trump Administration made a budget authority request for non-

defense discretionary programs in FY 2026 for $679 billion,

which is 32% below the $997 billion the Congressional Budget

Office had assumed as recently as January.

This represents a major shift in the spending habits of the

federal government and will, if enacted, lead to more resources

staying in the private sector. But, in the very short run, it might

also bring some transitory economic pain to those who rely on

that spending for their livelihood. The impact is not immediate.

In the meantime, uncertainty about tariffs might also

contribute to a slowdown. Already, imports are slowing after

their surge, and companies are hesitant to re-shore economic

activity because the timing and duration of tariffs is unknown.

The bottom line is that it’s unlikely a recession has started

yet, but investors should remain alert.