Mounting trade imbalances and collapsing confidence are flashing warning signs for the U.S. economy.
As new tariffs disrupt global supply chains and sow uncertainty among firms and households, early economic data suggests the economy may already be approaching a turning point.
Our forecast of a 0.8% drop in gross domestic product in the first quarter looks much more likely now as the trade deficit widened to a record high in March.
While some of the weaknesses in the trade deficit in the first two months of the year could be attributed to a surge in gold imports, which won’t be counted toward GDP, the spike in the trade deficit in March was driven largely by consumer goods.
Although some of that increase will most likely be offset by a rise in consumer spending or inventories, the significant bump in the trade deficit should remain a significant drag on GDP in the first quarter.
Still, a negative GDP print won’t be the reason for the National Bureau of Economic Research, whose task is to identify a recession, to say that a recession began in the first quarter, when the economy continued to add thousands of jobs and spending remained solid.
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But there is a risk of an inventory correction in the second quarter while spending drops off as tariffs kick in.
The uncertainty around trade policy could be another reason for a decline in business spending, adding more pressure to the overall economy. That is when we will have to monitor the labor market closely for any signs of cracks, which will most likely signal a recession.
Confidence and the labor market
Complementing the weakness on the trade front, recent softening in key sentiment and labor indicators offer additional cause for concern.
The sharp drops in job openings and consumer confidence reported on Tuesday are the telltale signs of how tariffs are viewed by the market. Consumer confidence, as measured by the Conference Board, reached its lowest level since the pandemic began five years ago.
Because of uncertainty, confidence from consumers and businesses has plummeted so quickly that most plans for business expansion through hiring have been postponed indefinitely.
As a result, job openings, a proxy for labor demand, are now back to the pre-pandemic level. But that also means businesses are not rushing to let go of their workers either as layoffs remain low.
No new plans mean no growth, which is not a good thing for businesses at the moment when borrowing costs stay elevated.
If the uncertainty around tariffs persists, the drop in spending while prices increase in the second quarter might be enough of a driver that could force businesses to make the tough decision of laying off their workers to save costs.
That would then lead consumers to pull back their spending as income falls, adding more pressure on declining orders that would again affect businesses.
The risk of a recession starting in the second quarter is now rising.
