Don't blame spending for soft second quarter GDP

The Bureau of Economic Analysis put forth its first release of second quarter US gross domestic product yesterday, and it was lower than anticipated. GDP grew 1.5%, less than the Bloomberg consensus of a 2.0% rate and the Federated Hermes estimate of 2.6%. The Atlanta Fed’s GDPNow tracking estimate, which fluctuates wildly, got this one right: spot-on at 1.5%. While the top-line figure was weaker than expected, the personal consumption component was a bright spot. It increased 3.2% quarter-over-quarter (q/q), far above estimates of 2.3%. This suggests the miss in overall GDP was nuanced and found in its many subcomponents.

That bump in personal consumption added 2.12 percentage points to overall growth. Fixed investment was also strong, contributing 1.2 points to the final reading. As you often hear, spending drives the US economy. Taken together, these components amounted to 84% of the final weighting of GDP, suggesting consumers and businesses are healthy. Of course, the federal government also spends. But it actually pulled back in the second quarter, trimming 14 basis points from growth. Two other subcomponents accounted for much of the remaining 16%. Private inventories subtracted 67 basis points and net exports 1.01 percentage points. The latter likely was due to the Supreme Court striking down many of the White House’s tariffs.

The crude truth The Iran conflict has sent crude oil prices on a roller coaster for many months. Since the start of the hostilities, gas prices at the pumps have risen 53% from $2.98 per gallon to a four-year high of $4.56 in May. They hover above $4 today. That hits consumers, but the Federal Reserve typically looks past oil costs because they fluctuate tremendously. So, it is a bit concerning that the increase has begun to filter into core inflation, which strips out volatile food and energy prices. Thankfully, the growth rates of the two major inflation indices, CPI and PCE, slipped in June. However, the recent reescalation in the region could see these drops short-lived. The oft-overlooked GDP Price Indicator rose 6.2% in the second quarter, its largest increase since the second quarter of 2022, placing nominal GDP at nearly 8% growth. While inflation might not be good news for new Federal Reserve Chair, Kevin Warsh, it is great for equities, whose revenues and earnings are in nominal dollars. It should come as no surprise then, that the S&P 500 Index rallied 15.2% in the quarter.

Fed on hold Chair Warsh’s Fed left the benchmark federal funds rate in a range of 3.50-3.75% at its policy-setting meeting on Wednesday, but three voters dissented in favor of a rate hike. It’s worth noting that the current range remains at a three-year low considering the many calls to raise it. That clamor — seen prominently in the bond market rally following the meeting — might be supported by a surprisingly soft initial weekly jobless claims of 188,000 for the week ended July 17. That is the measure’s lowest level since 1969. Yes, nearly six decades ago. If this trend continues and the labor market heats up, strength in the Fed’s other mandate of full employment might buttress the hawkish argument.

But the near-term focus remains on inflation, especially the staying power of elevated energy prices. Two-year Treasurys are yielding around 4.30% and fed funds futures are currently pricing in a two-third’s  chance of a rate hike at the September Federal Open Market Committee meeting.

Extraordinary earnings S&P 500 earnings are continuing their torrid pace. Bloomberg reports that with roughly 60% of the index having reported, second quarter earnings are growing at an astounding 57% year-over-year rate.  While that number is likely skewed by some investment gains from recent IPOs, the breadth of the surge has been wide. All 11 sectors of the S&P have reported positive earnings growth and all except for Consumer Staples were double digits.

What’s next? With most of the Magnificent Seven having already reported earnings, and the second-quarter GDP report behind us, eyes will shift to August economic releases. Most critical are the July nonfarm payroll report (August 7) and July CPI release (August 12), as well as Chair Warsh’s keynote address at the Kansas City Fed’s Jackson Hole central bank symposium on August 27.