In the second quarter, real GDP grew at an annualized rate of 2.8%. Notably, in seven of the last eight quarters, the economy grew faster than 2%. Keep in mind, that most economists believe that, in the long term, the US economy is likely to grow in the range of 1.5% to 2%. Thus, one could argue that the economy was on fire in the second quarter.
Let’s look at the details: In the second quarter, real consumer spending grew at a rate of 2.3%. This included growth of 4.7% for durable goods, 1.4% for non-durable goods, and 2.2% for services. Yet real disposable personal income only grew at a rate of 1%. This means that households reduced their saving in the second quarter. It also suggests that spending growth might weaken in the third quarter.
In addition, non-residential fixed investment grew at a rate of 5.2%, the fastest since the second quarter of 2023. This included growth of 11.6% for business equipment (computers, telecoms, transport goods), the fastest since the first quarter of 2022. Equipment investment accounted for 0.6 percentage points of GDP growth. In fact, until now, investment in equipment had stagnated since late 2022. That partly explained weakness in demand for consultative services. Thus, the strong rebound in the second quarter likely bodes well for our business. Meanwhile, investment in structures (office buildings, shopping centers, factories, warehouses) fell at a rate of 3.3% while investment in intellectual property (software, R&D) grew at a rate of 4.5%. Residential investment fell 1.4%. Finally, inventory accumulation contributed 0.8 percentage points to GDP growth.
Lastly, foreign trade had a net negative impact on GDP, with exports growing 2% while imports grew 6.9%. In addition, government purchases increased at a rate of 3.1%, led by defense purchases at 5.2%. Excluding the impact of foreign trade, grows domestic purchases were up at a rate of 3.5%. This is the final value of purchases made by US residents. It is a strong number, suggesting healthy domestic demand.
Although the economy was strong in the second quarter, there are signals of potential weakening. As such, this likely implies that the Fed will start to cut interest rates in September.
- In addition to GDP, the US government reported on consumer income and spending in June, the last month of the second quarter. As was true in May, real (inflation-adjusted) consumer spending grew faster in June than real disposable income. For this to happen, the savings rate fell in June. Going forward, if the deceleration in job growth leads to slower income growth, it could mean a slowdown in consumer spending once households stop reducing their saving. Meanwhile, the Federal Reserve’s favorite measure of inflation continued to improve in June.
In June, real disposable personal income (income after inflation and after taxes) increased 0.1% from the previous month. The personal savings rate (the share of disposable income that is saved) fell from 3.5% in May to 3.4% in June. It was the fifth consecutive month in which the amount of money saved fell from the previous month.
Consequently, real consumer spending increased 0.2% from May to June. This included a 0.2% decline in real spending on durable goods, a 0.5% increase for non-durable goods, and a 0.2% increase for services.
From a year earlier, real disposable income was up 1% in June while real consumer spending was up 2.6%. The latter included a gain of 2.9% for durable goods, 2% for non-durable goods, and 2.8% for services. The bottom line is that consumer demand has been stronger than income growth. The question is how long can this go on? As the late economist Herbert Stein once said, “If something cannot go on forever, it will stop.”
Yet this can continue for a while if households are willing to reduce their savings rate, dip into existing savings, and take on more debt. And, indeed, debt has been rising, leading some observers to worry about the probity of household finances. On the other hand, household debt service payments as a share of disposable income remain below the pre-pandemic level and dramatically below the level seen prior to the global financial crisis of 2008–09. Thus, it appears that households can continue to spend at a healthy pace.
Meanwhile, the government’s report on income and spending included data on the Federal Reserve’s favorite measure of inflation, the personal consumption expenditure deflator, or PCE-deflator. This measure was up 2.5% in June versus a year earlier, down from 2.6% in the previous month. More importantly, when volatile food and energy prices are excluded, core prices were up 2.6% in June versus a year earlier, the same as in May and the lowest seen since March 2021.
These numbers are close to the Fed’s 2% target. Moreover, it is worth recalling that the target is not meant to be a ceiling. Rather, it is meant to be an average. As such, the current inflation numbers are well within the Fed’s target range. Still, the details offer cause for concern. While prices of durable goods fell 2.9%, prices of services were up 3.9%, likely reflecting the impact of rising wages given that services tend to be labor-intensive.
For the Fed, the favorable inflation data, combined with evidence that labor market tightness is abating, bodes well for a rate cut in September. Indeed, this is what investors now expect. The futures market is now pricing in a 90% chance of a 25-basis-point cut in September. Investors think there is a 7% chance that the Fed will cut rates next week. Once the Fed starts to cut, it is likely that bond yields will follow, thereby leading to lower mortgage interest rates. This would probably boost activity in the housing market, creating a positive spillover effect on consumer spending on durable household products.
