Insight Investment

• Over the past few months, the US economy has transitioned from the “envy of the world” to one beset with policy uncertainty, cratering confidence, and at real risk of recession.
• So far, the signs of weakness are confined to the forward-looking “soft” survey data, with very little corroborative evidence in the backward-looking “hard” data.
• However, the economy exhibiting resilience may strengthen the Trump administration’s resolve to drive a hard bargain in trade talks and reduce its willingness to de-escalate.

The exuberance that dominated the early days of the second Trump administration increasingly feels like a distant memory. Unpredictable policy decisions have flustered businesses, markets, and consumers, and we are officially on recession watch.

After expanding by 2.5% (annualized) in the last quarter of 2024, the economy shrank 0.3% (annualized) in the first quarter of 2025. However, this is not necessarily a sign of impending economic doom. This decline can be singularly attributed to surging imports as businesses rushed to get ahead of tariff rate hikes. A massive 41.3% increase in imports shaved five percentage points from the headline GDP growth number. Stripping away volatile measures of international trade, inventory, and government purchases presents a more encouraging picture – real final sales to private domestic purchasers were up 3% last quarter, up a notch from the fourth quarter.

If the economy were to contract again in the second quarter, it would meet the most common definition of a recession. However, the National Bureau of Economic Research (NBER), the official “scorekeeper” of recessions, looks at six monthly indicators ranging from consumption to industrial production and jobs to determine whether the economy is indeed in a downturn. Thus far, all of them are flashing green.

Overall, a broad range of data shows the picture of the economy slowing down instead of one in free fall. At least for now, the signs of weakness are predominantly in the forward-looking “soft” survey data, with very little corroborative evidence in the backward-looking “hard” data.

Figure 1: The signs of economic weakness are mostly confined to “soft” data¹

Source: Macrobond, Insight Investment, as of May 13, 2025. “Soft data” consist of survey and business cycle indicators. “Hard data” is an equally weighted average of labor and housing market, industrial sector, consumer and trade sectors data. Data shows seven-day moving average.

However, the challenge from the perspective of US households is that even without a recession, a slowdown can be painful. In the short term, the pick-up in inflation will lead to higher prices, lower real wages, greater financial stress, and a meaningful pullback in spending.

Speaking of recession risk, the subjective odds of an economic contraction over the next 12 months appear to be uncomfortably high, and materially higher than earlier this year.

Perhaps counterintuitively, the flow of better-than-expected hard data may also reduce the Trump administration’s willingness to de-escalate.

At the same time, the tariff-induced upward pressure on headline inflation will likely be offset by near-term disinflation from lower energy prices, ongoing moderation in services inflation, particularly shelter, and what eventually may turn out to be softening in demand. Reassuringly from the Fed’s point of view, while near-term inflation expectations from consumers and businesses have picked up sharply over the past few months, longer-term expectations, particularly market-based ones, have remained well-anchored. However, the risks to our inflation outlook remain firmly skewed to the upside. 

The recent announcement from President Trump that the US and China negotiated a “total reset” in tariff talks (the two countries agreed to lower tariffs by 115%) supports our long-standing thesis that President Trump would eventually provide just enough policy adjustments before the detrimental effects of the tariffs derail the US economy. As a result, it appears likely that the economy may stumble in 2025 but should have enough momentum to skirt an outright recession.