America’s economy gave investors and policymakers a rude awakening on Thursday, June 26, 2025, when new figures were released and indicated that the country’s economic growth contracted by a much larger extent than it had been estimated before in the first quarter of the year. The Commerce Department’s third and last estimate showed real gross domestic product (GDP) declined at a 0.5% rate over the course of the year in January through March, a sharp revision from the previous reported decline of 0.2%.
This was the first three-quarter fall, turning around the 2.4% rise in the fourth quarter of 2024. Economists had forecast the fall in GDP to be unchanged at 0.2%. The weakness has prompted economists to raise concerns over the health of the world’s largest economy and question whether recession dangers are waiting in the wings.
Consumer spending hits multi-year low
The joltiest part of the revised GDP was the surprise downturn in consumer spending, the backbone of the American economy at almost 70% of overall economic activity. Growth in consumer spending collapsed to a mere 0.5% in the first quarter, below a previous estimate of 1.2%. This was the weakest rate of expansion in consumer spending since over four years ago and a steep decline from the 4% expansion in the previous quarter.
The weakness was strongest in recreation services, with spending dropping and taking away 0.14 percentage points from GDP – the strongest pull lower since the second quarter of 2020 during the pandemic. The drop indicates more general consumer restraint as families struggled with economic uncertainty and the impact of continuing trade tensions.
True final domestic purchases by private individuals, a union of consumer expenditure and gross private fixed investment, rose just 1.9% in the first quarter, which was short by 0.6% of earlier levels forecasted. Oxford Economics Chief U.S. Economist Ryan Sweet was quick to point out that “the details are more troubling because of the downward revision to real final sales to domestic purchasers, the engine of the economy”.
Trade war disruption weighs heavily on growth
The drop in GDP was attributed primarily to an unprecedented surge in imports as US corporations scrambled to stockpile goods in anticipation of President Donald Trump’s escalating tariff regime. Importing quantities jumped by a record 37.9% – the largest percentage since 2020 – lowering GDP by close to 4.7 percentage points. Although the last estimate trimmed import prices, they still significantly dwarfed exports, having a gigantic drag on overall economic performance.
This import surge was the culmination of the strategic reaction by U.S. businesses to evading the brunt of Trump’s combative trade policy, which included new Chinese import tariffs of 20% and 25% on Mexican and Canadian imports. The resulting disruption to trade unveiled the short-run economic cost of the protectionist approach of the administration.
The trade deficit was so bad that it contributed to narrowing the U.S. goods trade deficit by nearly half in April 2025, an all-time decrease after imports fell 20% once tariffs took full hold. The trade balance improvement came, however, at the expense of widespread economic disruption and muted business sentiment.
Inflation pressures mount despite economic weakness
To the economic decline, inflation pressures gained momentum in the first quarter even as the GDP declined. The personal consumption expenditures (PCE) price index, the inflation indicator of choice of the Federal Reserve, increased 3.7% over the first quarter, 0.1 percentage point more than earlier estimates. The core PCE price index, which excludes food and energy prices, which are volatile, also increased 3.5%, 0.1 percentage point more than earlier estimates.
This pairing of economic downturn and accelerating inflation is especially frustrating for policymakers as it constrains the Federal Reserve from using interest rate reductions to fuel expansion without heightening price pressures. The gross domestic purchases price index increased 3.4% in the first quarter after being revised upward 0.1% from the preliminary estimate.
Federal reserve faces steep policy decisions
The surprise GDP weakness has clouded the monetary policy landscape of the Federal Reserve, but policymakers do not appear to want to overreact to a single quarter of contraction. Markets have begun to price in potential rate cuts by June 2025 if additional signs of economic fragility emerge. Markets believe more obvious signs of economic weakness would have the central bank lowering interest rates by a full percentage point in the next year.
However, Federal Reserve officials face a delicate balancing act between supporting economic growth and managing persistent inflation pressures. The combination of GDP contraction and elevated inflation creates a stagflationary environment that limits conventional monetary policy tools. The Fed’s preferred approach of cutting rates to stimulate growth could backfire by further fueling price increases.
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