1Q25 was anything but typical. The early months of President Trump’s second term delivered sweeping policy changes that heightened uncertainty across financial markets. From federal spending cuts to an aggressive shift in trade policy, the administration’s “shock-and-awe” approach generated volatility across asset classes, sent inflation expectations higher, and provoked a sharp reaction from counterparts across the globe. While the U.S. economy remained on stable footing, several forward-looking indicators signaled a more challenging road ahead. As investors grappled with the shift in U.S. policy, they sought traditional safe havens, including U.S. Treasuries and gold, while U.S. equities repriced to reflect a more uncertain macroeconomic backdrop.

Policy

The Trump administration has had its sights set on reducing direct federal spending and, consequently, aims to reduce the federal deficit, which reached $1.8 trillion at the end of fiscal year 2024. One of the president’s key tools to cut costs has been Elon Musk and his Department of Government Efficiency (DOGE), which has been slashing potentially hundreds of thousands of jobs at federal agencies (the actual figure is unclear due to court battles), freezing billions of dollars of federal grant money, canceling contracts, and dismantling government agencies. The administration’s second tool, a politically aligned Congress, is now debating how to address mandatory spending (roughly 40% of total outlays, including Medicaid, Medicare, and Social Security) after having recently worked toward extending tax cuts. 

Trump 2.0’s approach to tariffs has followed a similar aggressive approach with an agenda of leveling the playing field by retaliating against countries that have placed trade controls against the U.S., and ultimately bringing manufacturing jobs back to the U.S. This includes tariffs on steel and aluminum products, on Mexican and Canadian goods, on Chinese goods, and ultimately broad-based reciprocal tariffs. The flurry of trade policy announcements, contentious comments from either side, and backpedaling progressively built anxiety in the markets as the administration’s agenda heightened uncertainty around inflation and created fears of an economic slowdown. The president and his cabinet were vocal that there could be short-term growing pains as they carry out their policy agenda. In an address to Congress the president even warned that there would be a “little disturbance” from his plan to impose sweeping tariffs.

At its March 2025 meeting, the Federal Open Market Committee (FOMC) held the Federal Funds Rate steady at 4.25% to 4.50% as it maintained a cautious tone. While two rate cuts are still projected for later this year, the Committee’s revised “dot plot” showed a shift in sentiment, with eight of the 19 voting members now anticipating only one or no cuts in 2025. The FOMC modestly raised its inflation forecast and trimmed its growth expectations. Inflation data for the quarter was mixed: headline and core CPI rose 2.8% and 3.1% year-over-year through February, both below consensus, while the Fed’s preferred measure, core PCE, came in slightly above expectations at 2.8%. Inflation breakeven rates widened, illustrating the market’s unease, particularly in the 2-year and 5-year segments where breakevens reached 3.3% and 2.6%, respectively.

U.S. Economy

While the U.S. economy marched forward, it began to show signs of a slowing pace and several indicators portrayed an uncertain road ahead. Real GDP increased at an annual rate of 2.4% in 4Q24, down from 3.1% in the previous quarter. A decrease in private inventories reflected strong demand, businesses adjusting to anticipated weak demand, or a combination of both scenarios. As 1Q25 progressed the Atlanta Fed’s GDPNow forecast for the first quarter fell deep into negative territory. It built an alternative model which adjusted for the surge of gold imports that was distorting the data, but that projection for 1Q25 GDP also ultimately turned negative by the end of March (-0.5%). This was in stark contrast to the Philadelphia Fed’s Survey of Professional Forecasters published in February, which had a median 1Q25 GDP projection that increased to 2.4% from 1.9% from the previous survey. However, if the actual first quarter print falls somewhere in between the two forecasts, it would signal a significant deceleration in the economy.

The manufacturing sector showed signs of deterioration as the March reading of the ISM’s Manufacturing PMI was down after having a short period of expansion. The ISM report also highlighted weakening demand as the New Orders Index fell for a second month in a row. Similarly, the Dallas Fed Texas Manufacturing Outlook Survey’s general business activity index registered at -16.3, its lowest level since July 2024. The Conference Board’s Consumer Confidence Index declined for the fourth consecutive month, and the outlook for income, business, and labor market conditions fell to the lowest level in 12 years. The Michigan Consumer Sentiment Index declined, with most consumers expecting unemployment to rise, registering the highest reading since 2009. The housing market also indicated weakness as building permits for private housing edged lower for a third consecutive month.

Not all was doom and gloom. Jobs data showed relative stability with unemployment holding steady (edged up 0.1 percentage points to 4.1% in February as reported by the BLS) and a decrease in average unemployment insurance claims in March. DOGE’s federal job cuts have yet to fully materialize in the unemployment data, but initial and continued unemployment insurance claims by former federal civilian employees were up from the year prior. The February Job Openings and Labor Turnover Survey highlighted little change in total separations during the month, with the largest increases in layoffs coming from retail (67,000), real estate (24,000), and the federal government (18,000).

Global Economy in 1Q25 and Currencies

Forecasts for global economic growth in 2025 have been revised slightly downward. The OECD projects global growth in 2025 moderating to 3.1% from 3.2% in the year prior, citing weakening business and consumer sentiment and significant changes in policies that, if sustained, would impact global growth and inflation. Major central banks maintained a cautious tone in 1Q, balancing disinflationary pressures with ongoing political and trade-related uncertainties. The European Central Bank lowered its deposit rate to 2.5% as growth has remained tepid in the euro zone, particularly in Germany and France. The Bank of England also cut its policy rate by 25 bps, citing progress on inflation and declining growth. Japan continued to deviate from the pack as its central bank raised its short-term policy rate 25 bps to 0.50%, reaching its highest level since 2008, and revised its inflation forecasts upward.

Protectionist policies came to the forefront as the U.S. imposed tariffs that led to retaliatory measures and renewed concerns of a global trade war. Tensions rapidly escalated as China reinstated tariffs on U.S. agricultural goods, the EU targeted U.S. industrial and meat exports, and Canada responded with countermeasures on U.S. steel, aluminum, and consumer goods. The disruption even pushed China, Japan, and South Korea to reopen dialogue on regional free trade for the first time in years, a highly notable shift driven by shared economic concerns. Volatility spiked across markets, including currencies, as President Trump’s trade policy took shape. The U.S. dollar (DXY Index) plummeted after reaching a two-year high in December. The heaviest decline was in early March when tariffs on Mexican and Canadian goods went into effect. Most of the major currencies and emerging market currencies appreciated relative to the greenback in 1Q. 

Closing thoughts

For closing thoughts, we’ve borrowed inspiration from our 1Q17 quarterly letter during President Trump’s first term—then, as now, markets entered a new administration at record highs. Valuations across equities and credit have reflected a high degree of optimism, if not complacency. While recent volatility has pulled markets off their peaks, the S&P 500 remains elevated, and credit spreads continue to hover near historical tights. In this environment, we encourage clients to temper expectations for returns and prepare for continued market turbulence. Uncertainty around the trajectory of U.S. fiscal and trade policy, coupled with evolving geopolitical risks, suggests that the road ahead may be bumpy. As always, Callan encourages investors to maintain a long-term perspective and prudent asset allocation with appropriate levels of diversification.