Front-Running Tariffs Distort GDP

The U.S. Bureau of Economic Analysis (BEA) reported that first quarter Gross Domestic Product (GDP), which is the broadest measure of economic activity, fell at an annualized pace of 0.3%.

Yet, a closer look reveals that the economy didn’t shrink in Q1. What happened? Businesses rushed to stockpile goods ahead of tariffs, which depressed GDP. Let’s explain with a simple example.

If Americans purchased 1,000 toasters in Q4 and companies imported 100 toasters from abroad, GDP, which measures domestic production, would effectively count 900 toasters, as 100 were imported.

If Americans purchased 1,100 toasters in Q1 and companies, anticipating tariffs, imported 300 toasters, this results in a net increase of 800 toasters, down from 900 in the previous period. Although consumer purchases rose by 100, the spike in imports weighed on GDP.

In Q1, imports jumped a record 41% (quarterly GDP records began in 1947), which shaved a staggering five percentage points off GDP, according to the U.S. BEA.

However, companies did not sell the massive influx of imports, leaving some to accumulate in warehouses across the country. This surge in inventories contributed more than two percentage points to GDP. Why? Inventories act as a balancing figure—when they increase, it adds to GDP; when they decline, it detracts from GDP.

Net the two categories, and GDP would have expanded in the first quarter. We might expect some of this to unwind in the second and third quarters.

But given the distortions in trade data, the economy during the first three months of the year was healthier than the headline number suggested.

One final remark: even amid the high level of economic uncertainty, stocks have recently mounted an impressive rally, with the S&P 500 rising for nine straight days (MarketWatch data).

Despite higher tariffs that remain in place, investors are hopeful that the delay in the most stringent levies, coupled with the ‘hope’ of new trade agreements, will enable the economy to sidestep a recession.

Trading on Headlines

The graphic below chronicles trading in the S&P 500 Index following the late-day announcement on April 2, referred to as “Liberation Day” by the president, regarding reciprocal tariffs.

What’s behind last week’s choppy action? Early in the week, investors responded unfavorably to President Trump’s warning that he might dismiss Fed Chief Jay Powell a year before the end of his term.

While the president has previously urged the Fed to lower rates, he raised the possibility of terminating the Fed chair in a recent social media post.

Many legal scholars question whether the president has the authority to terminate Powell, but the potential uncertainty surrounding such a decision led to a big drop in stock prices on Monday.

Why do U.S. and global investors prize an independent Federal Reserve?

Although the Fed does not operate in a political vacuum, “A politicized central bank opens the door to higher inflation, higher interest rates (bond yields), and a loss of confidence in the American financial system,” Morningstar said last Monday.

“If the US financial and political system is perceived as unstable, foreign investors may demand a higher return on their money to compensate for those risks,” the firm added.

In addition, many investors fear that a highly politicized Fed would maintain a low fed funds rate, which they worry could lead to a lasting rise in inflation and elevated bond yields. This concern is not limited to just one political party.

On Tuesday, the president said he does not intend to remove Powell, which lifted stocks as the uncertainty surrounding Powell’s tenure receded. A ratcheting down of U.S.-China trade tensions also contributed to positive sentiment.

Moreover, first-quarter earnings released through April 25 have exceeded expectations, per LSEG, further supporting share prices.

Flexing Economic Muscles

As we approached the early April selloff, much of the data suggested that economic activity was expanding. Let’s examine two important pieces of data.

Led by a 5.3% surge in auto sales, retail sales rose a strong 1.4% in March. While some buyers were hoping to jump in front of any tariffs (especially autos), February’s numbers were also respectable. As Figure 1 indicates, sales have been trending higher.

In their quarterly earnings releases, the major banks acknowledged that consumers are spending, according to the Wall Street Journal. Moreover, in its quarterly report, the CEO of American Express (AXP $251) said recent metrics are “in many cases, better than what we saw in 2024.”

But economic growth extends beyond just the ‘stuff’ you and I buy. After being stuck in a sideways pattern for over two years, life is returning to the industrial sector as evidenced by Figure 2.

The only reason industrial production was down 0.3% in March: a 6% decline in output from utilities. Otherwise, manufacturing rose for the 5^th month in a row, gaining 0.3% in March.

Given a massive surge in imports over the last couple of months (U.S. Census), as companies hoped to jump ahead of any tariffs that might be imposed, Gross Domestic Product may be weak or decline in the first quarter (a surge in imports subtracts from GDP).

Meanwhile, Dept. of Labor data points to a low level of layoffs, and job growth has been solid, according to the U.S. Bureau of Labor Statistics.

It added up to economic momentum heading into the recent market turmoil.