News & Insights

Weak First Quarter GDP Likely to Be Revised Up

An unexpectedly weak first-quarter gross domestic product reading may not reflect the U.S. economy’s underlying strength. The Bureau of Economic Analysts’ second estimate for the first quarter showed a 0.2% contraction in real GDP. A huge surge in imports in advance of possible tariff increases has obscured the quarter’s real growth. Detractors from GDP include weaker-than-expected inventory accumulation, soft consumer spending, reduced government expenditures and irregular seasonal adjustments.

While headline GDP was negative, actual economic activity was probably stronger. Typically, a rise in imports would be mirrored by an increase in inventories as businesses replenish stockpiles, but inventory growth was muted relative to import volumes, suggesting a measurement discrepancy. Since inventory fluctuations ultimately net out in long-term GDP trends, many analysts focus instead on real final sales of domestic purchases — a cleaner measure of domestic demand. While this indicator has cooled modestly from prior years, it remains far from recessionary territory.

Seasonal distortions also probably overstated economic weakness, with a recent Federal Reserve paper noting that seasonal overstatements in January inflation readings may skew GDP adjustments downward. Because inflation adjustments reduce nominal GDP to arrive at the real figure, inflated January price levels would artificially suppress subsequent real GDP prints.

Personal consumption was sluggish in January, a month that has shown erratic data in recent years. The drop in January contrasts sharply with stronger spending in February and March. While the slowdown in consumer spending is a notable concern, the negative GDP headline likely exaggerates the extent of economic deceleration.

Q1 GDP and Alternative Measures QOQ%

Source: Bloomberg

Component Contribution to Q1 GDP QOQ

Source: Bloomberg

A Federal Budget Replaces the Omnibus Continuing Resolution

Congressional committees are negotiating the terms of the "One Big Beautiful Bill Act," which seeks to replace the current omnibus continuing resolution with a formal budget framework. Understanding the trajectory of the federal budget requires examining both the current law and the potential implications of proposed changes.

The Congressional Budget Office, operating under the assumption that the 2017 tax cuts will expire this year, projects the federal deficit will rise to $1.9 trillion in 2025 and $2.7 trillion by 2035. Spending is expected to grow from $7 trillion today to $10.5 trillion over the next decade, trending well above historical levels of federal spending as a percentage of GDP. Federal debt held by the public — now equal to 100% of GDP — is projected to reach 118% by 2035, with gross federal debt increasing from $30 trillion to $52 trillion. Interest costs at current rates are over $1 trillion today, and are expected to climb to $1.8 trillion by 2035, consuming a growing share of total expenditures, and the domestic economy.

These record deficits do not reflect potential cost savings from the Department of Government Efficiency (DOGE), planned rescissions under the Inflation Reduction Act or surging tariff revenues. DOGE has identified $160 billion in annual savings, but Congress has dragged its feet in formalizing many of these cuts with legislation. In the meantime, tariff revenue has risen sharply, with $22 billion collected in May — more than double the figure from a year ago.

In their analysis of the bill, the CBO, Joint Committee on Taxation and the Committee for a Responsible Federal Budget suggest this budget could increase the deficit by approximately $2.4 trillion over 10 years. These estimates omit positive revenue effects from higher GDP growth triggered by tax cuts and incentives. They also exclude the additional interest cost from higher debt, which the CRFB estimates at $1.8 trillion. By contrast, the Office of Management and Budget, under the White House, claims the legislation will reduce the deficit by $1.4 trillion relative to current law. Regardless of these projections, the bill proposes just $1.3 trillion in spending cuts — woefully insufficient to offset the forecast $3.5 trillion increase in annual expenditures by 2035.

A late-stage revolt by fiscal conservatives led to deeper Medicaid cuts, while blue state Republicans insisted on a higher state and local tax deduction cap — from $10,000 to $40,000 — to secure additional votes. Critics are wary of temporary tax measures that expire in 2028, including exemptions on tips, overtime and car loans. Many of the spending cuts are back-loaded, which makes them vulnerable to future political reversals. The legislation would also lift the debt ceiling by $5 trillion.

With Moody’s recent U.S. credit downgrade and rising opposition in the Senate, the bill’s passage is now in jeopardy. Despite ongoing negotiations and the many moving parts on K Street right now, high federal spending and persistent deficits remain entrenched features of the current fiscal landscape and look likely to continue for the foreseeable future.

Projection for Total Outlays and Revenues as a % of GDP Under Current Law

Source: Congressional Budget Office

Front-Loading Tax Cuts, Back-Loaded Spending Cuts

Key Market Indices Performance

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