GDP Dips, PCE Calms: A Confusing Economic Picture Sends Mixed Signals to Markets

The U.S. economy contracted by 0.3% in the first quarter of 2025, a headline that initially sent equity markets reeling and reignited recession chatter. But dig beneath the surface, and a more nuanced picture emerges—one of tariff-driven distortions, healthy consumer and business demand, and inflation data that may ease the Federal Reserve’s concerns. The story of Q1 is less about an economy in decline and more about the challenge of interpreting volatile data in the fog of trade policy uncertainty.

The Bureau of Economic Analysis’ advance estimate for Q1 GDP showed the first contraction since the early days of 2022. The culprit wasn’t a collapse in consumer or business demand, but a historic 41.3% surge in imports, driven by a 50.9% jump in goods. Companies rushed to front-load shipments ahead of President Trump’s broad-based tariffs, implemented in early April. Because imports subtract from GDP, the front-running alone knocked nearly five full percentage points off the headline figure.

But the data wasn't all doom and gloom. Real final sales to private domestic purchasers—a cleaner measure of core demand that strips out volatile trade, inventories, and government spending—rose 3.0% in Q1, an improvement over Q4’s 2.9%. As Dan Greenhaus put it, “this is the ‘right’ way to look at the report.” In that light, the U.S. consumer and business sector remain in solid shape, even if the GDP print doesn’t show it.

Consumer spending slowed from a 4% gain in Q4 to a 1.8% pace in Q1, the softest reading since mid-2023. But March spending rose 0.7%, the best showing of the year, suggesting strength late in the quarter. Business investment jumped 21.9%, led by a 22.5% rise in equipment spending—likely another response to the tariff clock ticking down. Meanwhile, government spending—especially at the federal level—fell 5.1%, reflecting efforts by the newly established Department of Government Efficiency to cut costs.

In essence, the Q1 contraction may say more about front-loaded trade activity than about the health of the domestic economy. Shannon Grein of Wells Fargo called the GDP number “a relatively solid underlying report when it comes to demand,” despite the headline shock.

However, inflation was the other complicating factor. The price index for gross domestic purchases increased 3.4%, up from 2.2% in Q4. The Fed’s preferred inflation metric, the personal consumption expenditures (PCE) price index, rose 3.6% in the quarter, while the core index—excluding food and energy—rose 3.5%. On the surface, this is red meat for inflation hawks.

But the March data told a different story. The monthly PCE release showed that core prices were flat in March on a month-over-month basis, with core PCE rising just 0.028%, rounding to zero. The 12-month core PCE rate slowed to 2.6%, down from 3.0% in February. Headline PCE rose 2.3% year over year, only a touch above expectations. The Dallas Fed’s trimmed mean PCE—a less noisy measure—slipped below 2.5% YoY for the first time since 2021, signaling continued disinflation beneath the surface.

Markets initially reacted negatively to the GDP report, with stock futures falling and Treasury yields spiking. But as traders digested the internals and PCE data, sentiment improved. The S&P 500, which was down more than 2% at one point, trimmed losses to around 1.6%. Rate-sensitive assets reversed course as traders refocused on the March PCE numbers, which supported the case for a Fed rate cut as soon as June. Despite the quarterly inflation surge, the cooling in March may carry more weight given the Fed’s focus on recent trends.

Still, the economic picture remains clouded. With tariffs now in flux and global companies warning of erratic consumer behavior, data distortion is the norm. Economists widely agree that we’ll likely need to average out the first half of the year to get a clearer read on growth. One quarter’s contraction—especially one driven by one-time import behavior—isn’t enough to call a recession. But coupled with rising unemployment and ongoing policy uncertainty, it raises the stakes.

Mark Zandi of Moody’s put it succinctly: “The GDP report probably overstates the economy’s weakness—but the economy’s weak.” Even so, the underlying strength in private sector demand and the improving trajectory of inflation give policymakers—and investors—a bit of breathing room.