Tariffs upend Q3 economic outlook

Tariffs have impacted Morningstar’s third-quarter economic outlook, with predictions that they will push gross domestic product forecasts downward while increasing inflation.

Preston Caldwell, Morningstar Investment Management chief U.S. economist, discussed the impact that tariffs will have on the U.S. economy in the near-term during a recent webinar.

Morningstar’s economists continue to expect that the U.S. will avoid a recession while the annual inflation rate reaches the Federal Reserve’s target of 2%.

Caldwell predicted GDP for 2025 will grow by 1.7% and dip to 1.1% growth in 2026. In comparison, GDP growth for 2021 was 6%. Inflation is expected to be 2.7% in 2025 and rise to 3.2% for 2026, compared to a high of 6.6% in 2022.

“I think tariffs will ultimately cause an upward shift in prices, peaking in 2026,” he said. “After that, GDP growth will push inflation down, beginning in 2028.”

As for interest rates, Caldwell said he expects to see substantial further monetary policy loosening, with two interest rate cuts before the end of 2025, three in 2026 and another three in 2027.

Morningstar research showed a half-percentage point decline in GDP annualized quarter over quarter in the first quarter of 2025, Caldwell said. But he said that doesn’t foreshadow an economic slowdown “because the bulk of the decline was driven by a surge in imports, which subtracts from net exports, and in theory that should have been fully offset by higher accumulation of inventories,” he said. “Because all this surge of imports was coming into the country to beat the tariffs. Those goods have to be stored somewhere in inventories, but it just didn't show up in the data because of measurement error, which is not an unusual thing with the quarterly data.”

Taking that data out of the equation, first-quarter GDP was up on a quarter-over-quarter basis, he said. GDP is likely to rebound in the second quarter, although there are signs that consumers are more cautious about spending. Weaker consumer consumption combined with the tariff impact will lead to decelerating GDP growth later in the year.

Tariffs impact supply and demand

Tariffs bring both supply shocks and demand shocks, Caldwell said. From the supply side, tariffs put a drag on economic efficiency. On the demand side, they lead to fiscal contraction and uncertainty. Together, they pull down GDP.

So far, foreign companies have not paid the tariffs, he said. Right now, U.S. importing firms are paying for most of the tariffs, but not for long.

“I don’t think that’s sustainable,” he said. “Ultimately, the bulk of that cost will have to be passed on to consumers.”

Dave Sekera, Morningstar Research Services’ chief U.S. market strategist, said he believes there is still a lot of potential market volatility ahead in the next two months.

Markets often act like a pendulum, he said. Stocks began the year at a rare premium, plummeted to a rare discount and rallied back. Trade negotiations, the upcoming earnings season and the slowing rate of economic growth may lead to summer volatility.

“This is a great time to take a fresh look at your portfolio, look at your allocations and make sure they are balanced going forward,” he said.

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