The U.S. economy expanded faster than expected in Q2
The U.S. economy bounced back in the second quarter, expanding at a 2.4% annualized clip. That result solidly topped consensus forecasts for a 1.8% increase. The economy has now expanded at a pace at or exceeding 2.0% for four consecutive quarters.
Underlying the headline number were some interesting developments, including a partial handing off of the proverbial baton from consumers to businesses. In Q1, personal consumption expenditures increased at a 4.2% pace, effectively accounting for all of the growth in the economy for the period. Business investment was sharply negative, largely as a result of inventory depletion. Advance three months, and that part of the story looks markedly different.
Household consumption moderated in the most recent quarter, coming in at a gain of 1.6%. Consumption growth was skewed toward services (+2.1%) over goods (+0.7%) as consumers continue to rebalance their spending toward activities that were slower to recover in the aftermath of pandemic-related lockdowns and social distancing measures. Consumer spending on goods remains tepid as households push through the hangover effects from their stimulus-fueled buying binge on “stuff” in 2020 and 2021.
That relative restraint extended to housing, which was a modest drag again during the quarter — its ninth consecutive quarter of contraction dating back to Q2 2021. The combination of higher prices and higher interest rates remains an impediment to a more robust housing market, despite the significant underinvestment in single-family homes dating back over a decade.
Offsetting the slower pace of consumer outlays was a sharp uptick in business investment, which accounted for nearly half of the aggregate growth for the quarter. Wild swings in business inventories have been sloshing through the numbers in recent years — a byproduct of businesses trying to manage through supply chain challenges, delayed deliveries, and periodic shortages. Inventories rose modestly in Q2, providing a fractional lift to top-line growth.
Government spending, particularly at the state and local level, was also moderately accretive.
Beyond the surprisingly strong top-line growth, measures of inflation embedded in the report were largely positive, confirming previously released data that showed a marked slowdown in year-over-year inflation gauges. That’s the good news. The bad news is that despite its recent slowdown, inflation is still elevated, particularly core measures that don’t benefit from declining energy prices. Core price indexes have proven to be stickier and slower to revert toward the Fed’s 2% target, with housing specifically representing a significant portion of the index.
The combination of stronger-than-expected growth and sticky core inflation helps to explain the Fed’s decision to raise its short-term policy rate by another quarter point yesterday, while also leaving the potential for additional rate hikes still on the table.
The economy has expanded at a 2.2% pace this year — slower than the roughly 2.9% in the latter half of 2022 but still above most estimates of long-term trend growth. Such a pace should provide a solid tailwind for labor demand and job creation, complicating the Fed’s goal of loosening up labor conditions to further ease inflation worries.
Fed policymakers are still giving every indication that they are skeptical that inflation can normalize with unemployment remaining near its half-century low and an economy still churning out solid payroll gains. Wage growth has moderated, but it seems unlikely to ease sufficiently to satisfy Fed policymakers in the absence of a more pronounced increase in the unemployment rate.
The bottom line? Near-term recession risk still appears limited, despite a host of negative-forward indicators. The manufacturing and housing sectors have borne the brunt of prior rate hikes and changing consumer behavior, but the relative strength of the service sector and renewed support from business investment are doing more than enough to keep the economy pushing forward.
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