Gross domestic product slowed to 1.5% in the second quarter in the United States, but a large part of that slowdown can be attributed to a significant increase in the trade deficit that subtracted 1% from overall growth.
In the end, the top-line GDP figure, which decelerated from 2.1% in the first quarter, offers a misleading indication of just how strong the American economy is.
The rise in the trade deficit was caused by imports needed for the buildout of artificial intelligence infrastructure that is transforming the American economy.
If anything, those imports paint a portrait of strength, robust consumer demand and inflation that is a bit more persistent than the taciturn Fed Chair Kevin Warsh will acknowledge.
Beneath the top-line figure, growth looks much firmer and inflationary as the GDP price index advanced by 6.2% and the core personal consumption expenditures index, the Federal Reserve’s preferred measure of inflation, rose by 3.4% on a quarter-over-quarter basis.
The rise in the GDP price index was the sharpest since the 2022 inflation shock.
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The primary drivers of growth were robust household spending and non-residential investment, which is linked to the artificial intelligence buildout.
Fed policymakers will ignore that top-line number and focus on the robust consumer spending and recent jump in energy prices that have pushed inflation above 3%, well above the central bank’s 2% target.
This dynamic will inject an additional source of contention inside the raucous family fight at the Fed that has spilled out into public view.
The data
Household consumption increased by 3.2%, real final sales by 2.5% and final sales to private domestic purchasers excluding inventories and trade jumped by 3.9%. Gross domestic purchases increased by 2.5%.
Given the rise in imports linked to the AI buildout, we think that alternative metrics provide a much better look at underlying growth trends and resulting risks to the inflation outlook than the top-line GDP.
While we think that over the medium to long term the AI buildout will bolster productivity and cool growth in inflation, in the near term it will be a source of rising prices as demand for goods and services increases.
Outlays on goods increased by 5.2%, durables by 6.8%, non-durables by 4.4% and services by 2.2%.
Gross private investment increased by 3% and non-residential investment soared by 8.4%.
Fixed investment increased by 7%, while spending on productivity-enhancing equipment increased by 15.2% and intellectual property by 8.8%. Residential investment increased by 1.5%.
Exports increased by 4.5% and imports by 11.5% while government consumption declined by 0.8%. Inventory accumulation declined by $50.8 billion in the second quarter of the year.
Personal consumption and the PCE index
In separate report, the June PCE consumption and spending data reflected what one observed in the quarterly GDP data.
Spending is being fueled by wealthy households that are supported by rising wages and the wealth effect of an elevated stock market.
Nominal income increased by 0.2%, spending by 0.3% and real spending by 0.4%. June nominal spending was revised up to 0.9% from 0.7% while real spending increased by 0.4% in contrast with the 0.3% during the initial estimate.
Compensation, wages and salaries and disposable income all increased by 0.2% in the month.
The savings rate eased to 2.7%, while real personal income excluding government transfers increased by 0.2% and real disposable income advanced by 0.3%.
The PCE inflation index, which drew on out-of-date energy prices, is stale and is not representative of the true underlying pace of inflation that is at or above 3%. On a three-month average annualized pace, core inflation increased by 3.4%.
The June PCE price index and core metric declined by 0.1%. On a year-ago basis, top-line inflation increased by 0.7% and core inflation increased by 3.3%.
On a year-ago basis, goods prices increased by 3.7%, durables by 2.9%, non-durables by 4.1% and services by 3.7%.
The takeaway
Growth in the U.S. economy slowed because of a sharp increase in the trade deficit driven the buildout of AI.
Once one looks beyond the 1% drag in top-line growth due to the increase in the trade deficit, the growth picture looks much more solid, driven by robust household spending and non-residential investment.
But it is equally clear that inflation is broadening and looking much more persistent than the Federal Reserve is acknowledging.
With the credibility of Warsh and Fed under challenge by investors, we think that the central bank is being pushed into a corner where it may need to hike rates at the September meeting.
