Economic Outlook for Q2 2025
Quarterly Economics Briefing–Q2 2025
Posted Date: June 25, 2025
Key Themes and Takeaways
- Policy changes in early 2025 have led to a heightened sense of economic uncertainty.
- Uncertainty around tariffs and their impact on consumer spending have increased recession probabilities; however, economic data has shown little sign of deterioration so far in 2025.
- For workers compensation, tariffs may lead to higher medical prices and could disrupt the labor market, impacting premium and frequency trends.
State of the Economy and Its Impact on Workers Compensation
Several weeks ago, we presented the economic outlook at our Annual Insights Symposium.1 While we encourage everyone to watch the presentation, some might prefer to read about the outlook instead. In this brief, we will summarize the key takeaways from 2025’s State of the Economy presentation as well as provide several updates based on new information in the weeks since the presentation.
1 The State of the Economy and Its Impact on Workers Compensation, Stephen Cooper, Annual Insights Symposium 2025, May 14, 2025.
Growth and the Broad Economy
Early in 2025, the narrative surrounding the US economy was that of exceptionalism. The US economy had continued to grow strongly in the face of headwinds, vastly outperforming developed market peers since 2019. That narrative, however, has been replaced with one of economic uncertainty and caution as fiscal policy changes were announced and put into effect. Since the beginning of the year, economists have sharply lowered their forecasts for Gross Domestic Product (GDP) growth in 2025 and sharply raised their probabilities of a recession. Uncertainty reigns supreme; however, the data has yet to show material evidence of any impacts from these policy changes.
We do have one negative economic data point from early 2025. In the first quarter, the economy shrank for the first time since early 2022. GDP growth from Q4 2024 to Q1 2025 was –0.2% at an annualized rate. This may have been interpreted by some as confirmation of the lowered GDP forecasts for 2025, but we would urge caution in this interpretation. While the economy was certainly influenced by the aforementioned fiscal policy changes, the impacts seen in Q1 GDP are a little more complex.
The economy contracted in the first quarter due to a significant rise in imports. As companies and individuals pre-bought goods in order to get ahead of tariffs, net exports subtracted nearly 5% from the economy in the first quarter. But a more focused measure of the economy, real final sales to private domestic purchasers (the sum of consumer spending and fixed investment), grew a solid 2.5% in the first quarter. The large distortion from trade activity in the first quarter will likely wash out later in the year. We have already seen this begin to happen as import activity sharply fell in April.
While we do not view the Q1 GDP report as an early sign of the true impact of policy changes on the economy, there are other data points to assess the health of the economy and whether a recession might be coming. In particular, we focus on the most influential driver of the economy—consumer spending.
Consumer spending is the backbone of the economy, making up nearly 70% of GDP. Since the pandemic, an interesting trend has developed: despite consumer confidence continually dropping to near Great Recession (2008–2009) levels over the past several years, these negative feelings about the economy have not altered spending behaviors.
Many fears of a recession in 2022 and 2023 that did not come to pass focused on the negative attitudes of consumers, reasoning that spending patterns would not hold up in the face of higher inflation. Those same fears have once again reignited as uncertainty over the impact of tariffs and other policies has caused sentiment to return to recent lows.
However, as long as consumer spending continues to grow, as it has for the past several years, a recession is unlikely to materialize. Consumers weathered the previous round of price increases, thanks in part to higher wages, excess savings carried over from the pandemic, and increased borrowing. This time, consumers may not have as many tools in their tool belts to offset a potential second round of higher prices, which is contributing to uncertainty in the outlook.
If this potential consumer weakness translates into broader economic weakness and a recession, the impact on workers compensation will largely depend on the shape of the recession.2 Shorter and shallower recessions, such as 1990 and 2001, have a minimal impact on trends in workers compensation premium, frequency, and severity. Longer, deeper recessions, such as 2008 and 2020, can have larger impacts. Larger employment losses during these types of recessions lower premium for the industry. As workers are added back during a subsequent recovery, more low-tenured workers can also lead to temporary increases in frequency.
2 For a deeper dive into recessions and their impact on workers compensation, check out “How Do Recessions Affect Workers Compensation?”, Quarterly Economics Briefing, Patrick Coate, ncci.com, October 16, 2019.
The Labor Market
So far in 2025, the labor market has yet to show any material signs of weakness. This may be a comforting data point for some, but the labor market tends to be a lagging indicator of the overall economy. Typically, by the time labor market data starts to show consistent employment declines, the economy is already in a recession. So, while the labor market has remained resilient so far, with job growth averaging 124,000 per month, this does not tell us much about what may still come.
Although the labor market doesn’t give a solid indication of where the economy might be heading, its resilient performance so far in 2025 has kept payroll growth elevated for workers compensation. Overall payroll growth of around 5.5% for 2024 has been followed by a similar level of payroll growth year-to-date in 2025. While strong in the aggregate, payroll growth at the industry level has become more concentrated. Only a few industries added a significant number of jobs, and wage growth has also become more uneven. These patterns are likely the result of the labor market continuing to reorient following the large distortions coming out of the pandemic rather than early signs of a broad-based deterioration.
While much of the focus of economic uncertainty has been on the risks of a recession, there have also been policy changes that might call the longer-term trajectory of the labor market into question. Foreign-born workers represent a small share of the overall labor force, about 20% in 2024 but collectively they have made up over half of all labor force growth since the Great Recession. Therefore, a longer-term reduction in the supply of labor could constrain labor market growth in the future. Additionally, a lack of available workers could lower premium growth for workers compensation and potentially impact frequency trends.3
3 “Economic Outlook for Q4 2022,”, Quarterly Economics Briefing, Patrick Coate, ncci.com, January 31, 2023.
Tariffs and Inflation
The largest contributor to uncertainty around the economic outlook in 2025 has been tariffs and trade policy. Keeping track of the current state of trade policy has been challenging, not just for economists trying to assess the impact to the outlook but also for business leaders attempting to plan for the future.
Aside from the uncertainty around the changing tariffs and trade policies, the direct impact of tariffs also matters. Definitionally, tariffs are a tax on imports. Functionally, the purchaser of the imported good (a US consumer or US company) pays the tax at the border before a good is allowed through customs. Because of this, tariffs function as a consumption tax, similar to a state sales tax paid by the purchaser at a store. Tariffs often raise the cost of imported raw materials and components, increasing production costs for domestic firms. As prices rise for both producers and consumers, output can fall, leading to fewer goods produced and sold. Both outcomes can have negative impacts for the economy: lower GDP and more pressure on price-sensitive consumers.
Tariffs will have varying impacts on prices, depending on the type of good, country of origin, whether or not there are easily sourced substitutes, as well as other factors. However, the net impact is usually that prices will be higher. Whether or not tariffs cause inflation, a repeated increase in prices is less impactful than whether consumers will be willing or able to continue to increase spending through another increase in prices.
In the weeks following the presentation at AIS in mid-May, a three-judge panel of the US Court of International Trade ruled that the tariffs imposed under the International Emergency Economic Powers Act (IEEPA) of 1977 exceeded the Administration’s authority. However, the US Court of Appeals for the Federal Circuit subsequently ruled that the tariffs imposed under IEEPA could remain in effect while appeals proceed, with appellate arguments expected to take place this summer. The Court of International Trade’s decision did not affect all tariffs that have been imposed, such as those against China under the Trade Act of 1974 or the tariffs on steel, aluminum, and automobiles under the Trade Expansion Act of 1962. Whatever the ultimate outcome of these cases may be, tariffs have been a cornerstone policy of the Administration and may still be pursued under alternative policies; therefore, one way or another, we believe the weighted average tariff rate will be much higher this year than it was last year.
For workers compensation, tariffs will have both direct and indirect impacts. Directly, imported durable medical equipment, supplies, and pharmaceuticals will face higher prices from the increased tax paid by importers. These categories make up roughly 15% of workers compensation medical costs. Indirectly, higher prices for medical equipment and supplies may increase prices for physician, hospital, and long-term care services over time as higher input costs are passed through to the end consumers. Keep an eye out for the next Medical Inflation Insights report on ncci.com to learn of any impacts to workers compensation medical prices.
Interest Rates and the Fed
Earlier this year, the Federal Reserve put a pause on additional interest rate cuts. Increased uncertainty over the economic outlook and increased uncertainty around the trajectory of inflation and the labor market have likely put the Fed into an extended wait-and-see phase until the ultimate impacts of these policies are known. This was confirmed at the Fed’s most recent meeting with the update to their forecasts.
While some people may have expected short-term interest rates to continue to fall in 2025, longer-term interest rates have been much more interesting to watch. Despite increasing uncertainty around the economic outlook and higher probabilities of a recession, longer-term yields have remained elevated. While many factors influence long-term bond yields, one of the largest outstanding questions is the trajectory of the national debt and recurring budget deficits.
The national debt total now sits above $36 trillion. That’s a big number. However, when compared to national income (GDP) of $30 trillion, the debt picture might not seem as daunting. At roughly 120% of national income (GDP), compare this debt share to a household with a $120,000 mortgage loan and an annual income of $100,000. When viewed in that lens, it may not be quite as concerning. What is alarming, however, is the deficit. Because the government does not run a balanced budget, with spending exceeding revenue, the debt continues to grow over time, instead of shrinking.
While much has been said about the negative impacts of tariffs on prices and economic growth, an increase in tax rates generally does lead to an increase in tax revenue. Tariff revenue, however, is difficult to predict because there is some uncertainty as to what the level of tariffs and imports impacted will be going forward. Increased tariff revenue is likely to have a positive impact on deficits over time; however, these benefits may be offset by other tax cuts or spending initiatives.
Conclusion
In 2025, the narrative of US economic exceptionalism has been replaced with one of significant uncertainty. Higher prices from tariffs have threatened the economy in the near term while changes to the supply of labor may impact economic growth in the future. Despite the uncertainty, if consumers continue to weather higher prices, the economy is better positioned to avoid a recession. However, that resilience may be tested further. Tariffs risk driving prices higher, dampening demand and potentially tipping the economy into contraction. At the same time, persistently high budget deficits are contributing to elevated interest rates, which could further restrain investment and growth.