Economic Outlook

Growth

Growth in the US economy, as measured by real GDP, contracted 0.5% in Q1 2025 and then grew by an impressive 3% in Q2, based on the headline numbers. However, the details show that both numbers were significantly distorted by unusual trade activity related to the imposition of new import tariffs.  Growth in the US economy is not as weak as indicated by the first quarter GDP number, but it’s also not as strong as suggested by the second quarter number. The details behind the GDP numbers indicate why: the calculation of GDP includes an adjustment for trade, and the US runs a trade deficit with the rest of the world, meaning that it imports more than it exports. Net imports are a subtraction from overall GDP, so when imports surge, GDP declines. And when imports decline, GDP will rise, all else equal.   

In the first quarter, imports accelerated due to businesses trying to beat the new tariffs that were announced on April 2. In the first two quarters of this year, net imports had the biggest impact on overall GDP ever recorded. Imports were responsible for a negative 4.6% adjustment to the overall estimate of growth in the first quarter and a positive 5% adjustment in the second quarter. This, in an economy that is growing at a less than 3% trend rate. We typically look to real GDP as the prime indicator of growth in the US economy, so with such large distortions stemming from trade, what can we rely on for a more stable indication of US growth?

The US is a consumer-driven economy, so overall sales, adjusted for inflation, are probably a better indicator of core growth than total GDP in the present environment. Real sales (listed as “Real Sales to Private Domestic Purchasers” in the GDP report) were up 1.2% on an annualized basis in the second quarter and have remained positive, but on a downward trend, for the last three quarters. Over the prior 12 months, sales growth averaged over 2%. 

So, in our view, the US economy is not as weak as indicated by first quarter GDP and not quite as strong as suggested by second quarter GDP. Personal income was up a strong 3% in the second quarter and personal consumption remained positive at 1.4%. The savings rate increased. Savings are a two-edge sword though—on the one hand they improve household balance sheets, but on the other hand they are generated through reduced spending. The US economy is growing, but it is doing so at a slower pace than in 2024.

Investors and business leaders may want to give special attention to subsequent revisions to GDP and our other primary economic indicators. These revisions have been getting larger in recent quarters and can change our view of overall economic performance. Revisions tend to get larger at inflection points in the economy, and there is evidence that collecting the raw data required to estimate economic activity is becoming more difficult. Measuring something as large and as complex as the US economy is never easy, and the agencies charged with doing so are dependent on surveys of businesses and households.  Both are showing signs of survey fatigue. Response rates are declining, making the business of economic measurement more challenging.

Employment

• Payrolls increased by a scant 73,000 in July
• Revisions to prior periods put the 3-month average at 35,000 jobs per month
• Unemployment held at 4.2%

The US economy added only 73,000 jobs in July. Revisions to prior periods made the report even more disappointing. The average monthly additions to payrolls are now 35,000 for the last three months. It is estimated that the US needs to add about 100,000 jobs per month just to keep up with population growth. Although immigration is no longer adding to the labor force at the same rate as it has in recent years, recent college graduates are now finding it more difficult to find jobs. Unemployment has gradually moved up from 3.4% two years ago but still remains low at 4.2%. Declines in the “participation rate,” or the proportion of people actively working or looking for work, has also helped keep that number low. Working-age people dropping out of the workforce holds the measure of unemployment down, even when job formation slows. Wage increases have held to levels that should not contribute very meaningfully to inflation. Reported job openings have declined to 7.4 million, only slightly higher than the number of unemployed workers, which stands at 7.2 million. In the post-COVID recovery, there were two jobs for every unemployed person. Although concerning, the jobs report, taken by itself, would support an interest rate cut later this year by the FOMC.  

Inflation

• Both “Core” and “All Items” CPI ticked up in June
• June CPI was 2.7%
• Core CPI was 2.9%
• Improvement in inflation may have stalled 

For the 12 months ending in June, CPI inflation was 2.7%. Both core and headline inflation were higher in June than in May. Piped gas and electricity rose, but these were partially offset by lower prices at the gas pump and in heating oil. Food was up 3% YOY, shelter was up 3.8% YOY, and increases in the cost of housing continue to weigh on household budgets. High prices, high mortgage rates, and rising insurance costs are combining to inflate the biggest line item in US family budgets. One month does not make a trend, but the May report suggests that progress on inflation may have stalled at a level above the Fed’s 2% target. Even though inflation is a measure of the rate of change in prices, not the overall level of prices, the consumer’s perception of inflation remains elevated because prices remain elevated. 

Tariffs, which probably will add to the cost of many goods, do not yet appear to be fully reflected in the rate of inflation. Tariffs have the potential to impact both business margins and consumer costs. However, tariffs should show up as a one-time adjustment in the price of imported goods and not as an ongoing contributor to the rate of inflation. 

Interest Rates

• The Federal Reserve is widely expected to cut in September 
• Short-term target rate held at 4.25%–4.50%
• Key 10-year Treasury rate is at 4.2%

The Federal Reserve’s Open Market Committee met on July 29 and 30. Despite considerable political pressure to cut, they left their target for short-term rates unchanged, as they did at their last meeting.  There were two dissenting votes from members who wanted to cut interest rates. Dissents are rare but tend to be more common at policy inflection points. The target rate for overnight interest is 4.25–4.50%.  Most forecasters, and action in the futures markets, indicate that we may see a cut at the September 17 meeting. Recent weakness in the jobs market would certainly argue for a cut, as would the apparent slowing in growth of the US economy. We will get two more inflation reports prior to the September meeting, as well as one additional jobs report. If inflation comes in hot, the Fed will face a very tough choice. The Fed has been holding rates high in an effort to bring inflation back down to 2%. However, if current trends continue, economic conditions would support a couple of interest rate cuts prior to the end of the year. While markets would probably welcome such cuts, they may not help the housing market to the extent needed. Mortgages are tied to longer-term rates, and the Fed has very little influence over those rates, using its conventional tools. Longer-term rates are determined by yields on Treasury bonds, and those remain stubbornly high because of the massive borrowing required to fund our ongoing federal deficits.  

Markets

• Stocks keep finding new highs
• International stocks outperforming US
• Bond yields are attractive 

Between mid-February and early April, the S&P 500 sold off 11% in response to announcements regarding new import tariffs. That index has recovered 14% from its April low and recorded several new all-time highs since then. Overall, the S&P 500 is up 5.9% YTD on price action alone. Earnings have been supportive and have generally come in at or above estimates, however, most of the recent appreciation in stocks is coming from multiple expansion. Investors are paying more for each dollar of earnings than in the past—the price-earnings multiple of the S&P 500 stands at 29 versus a long-term average of 16. At the post-COVID low, the price-earnings multiple was 20. These measures have generally trended higher in recent years and that certainly made some sense when interest rates were very low. A company’s value is based on an estimate of the present value of its future earnings, and any present value calculation rises as interest rates fall. In the present environment, interest rates are not especially low, and yet stock valuations have continued to rise.

International stock indexes, which have trailed their US equivalents for the last several years, have outperformed domestic stock indexes in this volatile environment. The MSCI World index is up 9.7% YTD. Investors seeking diversification may want to consider exposure to international stocks.

Real interest rates on bonds (the yield above the rate of inflation) are at highs not seen since 2007.  Investors seeking preservation of capital can earn interest at rates above the pace of inflation, a condition not seen in the ultra-low-rate environments following the financial crisis and COVID. One index of high quality 5-year corporate bonds currently yields over 4.5%. Furthermore, since bond values move in the opposite direction of interest rates, if rates do come down in the future, bond portfolios could also appreciate. 

If we can help you navigate this changing business climate, please do not hesitate to contact your United Community banker. We appreciate your readership.