Factory Activity Slumps as Tariff Costs Weigh Heavily, Despite Q2 Growth Rebound

Manufacturing PMI drops to 49.5, signaling the first contraction since December 2024. Meanwhile, the Atlanta Fed’s GDP tracker projects 2.4% growth for Q2, with official numbers due July 30.

America’s manufacturing sector is sounding an alarm.

The S&P Global US Manufacturing Purchasing Managers’ Index fell to 49.5 in July, slipping below the 50 mark that divides growth from decline. This marks the first contraction in factory activity since December 2024. Production slowed, new orders dropped for the first time this year, and both jobs and inventories shrank for the first time since April. While supply chain bottlenecks eased, leading to faster delivery times, this actually dragged the PMI lower due to the index’s methodology.

Despite the factory slowdown, the broader economy seems poised for a solid recovery this spring. The Atlanta Fed’s GDPNow model estimates 2.4% annualized growth for Q2 2025, a sharp turnaround from the 0.5% contraction in Q1, which was hit hard by a spike in imports. This quarter, a reversal in trade flows is boosting growth, and the model’s recent updates have been steady.

The real test comes next week. On Wednesday, July 30, at 8:30 a.m. ET, the Bureau of Economic Analysis will release its first estimate of Q2 GDP, giving a clearer picture of whether this rebound has legs.

Tariffs: A Double-Edged Sword

S&P Global highlights a growing tension: higher tariffs may shield some industries but often hurt manufacturers overall. While tariffs can protect certain sectors, they drive up input costs, squeezing profits for companies further down the supply chain and sometimes costing jobs where businesses can’t pass on higher prices. Retaliation from trading partners or shifts in global supply chains can further erode the benefits, leaving US firms grappling with higher costs and uncertainty.

We’ve seen this before. Past tariffs on steel and aluminum raised costs for manufacturers with only fleeting gains in output or jobs. The latest wave of tariffs on consumer goods and key components could repeat this pattern, hitting factories just as momentum fades.

A Classic Late-Cycle Struggle

The economy is caught in a push-and-pull dynamic typical of late business cycles:

Bright spots: A rebound in net exports is fueling Q2 growth, and faster supplier deliveries are smoothing out operations.
Trouble spots: The PMI’s slide into contraction, weakening capital spending (core capital-goods orders fell 0.7% in June), and rising tariff costs are hitting industries hard.

The economy can still grow, thanks to stronger services activity, but its potential is capped. As tariffs push up prices, the risks of slower growth and persistent inflation are climbing.

Why the PMI Drop Stings

The PMI’s decline stands out because it’s widespread:

New orders weakened, signaling softer demand ahead.
Employment fell, showing factory managers are quick to cut back.
Inventories shrank, as firms brace for higher costs by keeping lean.

The improved delivery times are a mixed bag. They reflect a post-pandemic easing of supply chain woes, which could help profits over time. But in the PMI’s math, faster deliveries lower the score, slightly masking the operational gains.

The Big Date to Watch

Attention now shifts to July 30, when the BEA’s first GDP estimate will either confirm or challenge the Atlanta Fed’s 2.4% growth projection. The model’s recent stability suggests no major surprises, but the details—especially inventory levels and real investment strength—will reveal whether Q2’s rebound is a turning point or a temporary lift.

Key Data Points (as of July 25, 2025)

S&P Global US Manufacturing PMI: 49.5 — first contraction since Dec 2024
Atlanta Fed GDPNow (Q2 2025): +2.4% annualized — holding steady
Q1 2025 GDP: –0.5% — dragged down by imports
BEA Q2 GDP release: July 30, 2025, 8:30 a.m. ET

The Takeaway

America’s factories are hitting the brakes, with tariffs adding extra pressure. The services sector and improving trade dynamics are keeping Q2 GDP afloat, but rising costs and softening factory demand point to a tougher road ahead. The risk of slower growth paired with stubborn inflation is growing.

Next week’s GDP report won’t end the debate, but it will show whether Q2’s momentum can keep the economy from stumbling in this late-cycle balancing act.

Investment Thesis

Category	Key Data/Insights
Base Case (55% prob.)	GDP advance print (30 Jul) between 1.8%-2.2% SAAR; mild H2 slowdown due to tariffs and manufacturing destocking.
July PMI Signals	- Headline: 49.5 (contraction) - New orders: 48.1 (first drop in 2024) - Output: 50.2 (barely positive) - Employment: 49.0 (soft hiring) - Supplier deliveries: 55.6 (faster, drags PMI) Takeaways: Inventory overhang (not demand collapse) driving slowdown; tariffs re-accelerating input costs.
Tariff Impact	- Effective tariff rate: 20.6% (highest since 1910) - CPI impact: +2.1pp short-term - GDP impact: -0.9pp in 2025 Winners/Losers: Upstream mills (steel/aluminum) benefit; mid-stream assemblers/apparel hurt. Responses: Shift supply chains to Mexico/ASEAN, automate, hedge commodities.
GDPNow vs. Advance GDP	- Net exports: +0.8pp (upside) - Consumption: +1.3pp (neutral) - Inventories: -0.3pp (downside) - Business investment: +0.4pp (downside risk) Bias: GDPNow may overstate by 0.3-0.5pp due to weak inflation-adjusted equipment investment.
Policy/Markets	- Fed: Hold at 4.25-4.50% (hawkish on tariffs) - Curve: Flattening 2s-10s by 10bp - Equities: S&P 500 at 21.5x forward EPS discounts 4% 2026 growth; fragile due to margin risks. Overweight services, underweight cyclicals.
Corporate Playbook	1. JIT inventories, buffer stocks for tariffs. 2. Staged price hikes now. 3. Delay foreign-content capex; prioritize automation. 4. Dual-source in Mexico/Vietnam. 5. Hedge USD strength via 6-12m forwards.
Scenarios (12-month)	- Baseline (55%): 1.1% H2 GDP, 3.1% core PCE, Fed cuts Dec-25. - Downside (30%): 0-0.5% GDP, 3.4% PCE, Fed holds till 2026. - Upside (15%): 2%+ GDP, 2.8% PCE, Fed cuts Sept-25.
Key Dates	- 30 Jul: GDP advance, FOMC. - 1 Aug: New 35% tariffs, ISM. - 12 Aug: CPI. - Late Aug: Jackson Hole.
Bottom Line	Asymmetric risks: Services support growth, but tariffs cap upside. Investors: Barbell (defensives + secular growth). Corporates: Prioritize agility/pricing power.

NOT INVESTMENT ADVICE