- On the surface, the U.S. economy moderated in the second quarter to a 2.1% annualized pace, slightly better than the 1.8% markets were expecting.
- Final domestic demand was much stronger than the headline suggests, up 3.5%, after a soft 1.8% in Q1. As expected, a drawdown in inventories subtracted nearly a full percentage point from headline growth (-0.9%-pts), reversing the boost to Q1.
- Consumers were the key driver of domestic demand strength. Spending bounced back 4.3%, after a soft 1.1% pace in Q1. Consumer spending was strong across categories, led by a 13% jump in durable goods, but nondurables (+6%) and services (+2.5%) were also healthy.
- Government spending also accelerated in the second quarter, rising 5% as normal federal government activity (+7.9%) resumed after the shutdown in the first quarter. Spending growth at the state and local level continued to be sturdy (+3.2%).
- The softness in the report came on the investment side of the economy. Nonresidential investment was down slightly (-0.6%). Investment in structures fell further than anticipated (-10.6%). Spending on equipment rose very slightly (+0.7%) after remaining essentially flat in Q1. The bright spot in investment continues to be intellectual property products which rose 4.7%, a healthy follow through after a 10.8% gain in Q1.
- As expected, residential investment continued to be weak in the second quarter. It fell (-1.5%) for the sixth consecutive quarter.
- Exports fell further than expected (-5.2%). As outlined in our recent report, manufacturing exports have weakened as a global chill slows US manufacturing. Imports were also a bit weaker than anticipated, up only 0.1% in Q1, so net exports still subtracted from growth (-0.7%-pts) reversing the boost in Q1.
- Finally, largely as expected, price pressures eased in the second quarter, with the core PCE deflator up only 1.5% on a year-on-year basis.
Key Implications
- As the temporary factors that lifted GDP growth in the first quarter reversed in the second, the report is again a mixed bag. On the one hand, the consumer came roaring back to life in the second quarter, and remains the growth stalwart of the U.S. economy, unbowed by gathering clouds on the global scene. On the other hand, weakness in investment spending and exports suggest that slower growth globally and uncertainty on the trade front are hurting activity in some sectors.
- Overall, today’s report paints a picture of a U.S. economy that may be on two tracks. The consumer remains strong. Government is also spending, and the budget deal struck this week in Congress helps reassure that spending will not drop off a cliff heading into 2020. But the investment side of the economy is lackluster.
- It is the latter the Fed is likely to focus when it cuts rates 25 basis points next week. It has signaled its desire to cushion the American economy against the global slowdown and further downside risks stemming from trade uncertainty. Recent speeches by Fed officials have confirmed that the Fed should act pre-emptively given the fed funds rate is still relatively low. Today’s report also confirmed that inflation remained below the Fed’s target in Q2, helping to make the Fed more comfortable easing policy.
