- This was a “goldilocks” GDP report, with enough strength to be reassuring but not so much that it weighed on the likelihood of a September rate cut.
The economy grew at an annualized pace of 2.8% in the second quarter, after adjusting for inflation. This was well above expectations of a 2.0% increase and acceleration from last quarter’s 1.4%. It’s a very solid, but not spectacular, number, just in the top half of all quarters since 2010, but looking at it in the context of the rate environment shows just how resilient the economy has been. Remember, an upper bound on the fed funds rate target of just 2.5% almost broke the economy in 2019. The current economy has powered through the most aggressive rate hiking regime in over 40 years with the top of the fed funds target rate sitting at 5.5% for almost a year now.
For markets, GDP is typically one of the least important economic data points because the numbers are relatively stale. Markets aren’t taking their bearing from what happened in April and May. At the same time, it’s the best broad measure of economic activity we have. The positive surprise also tells us the economy was running a little stronger than what might have already been “baked in” to market prices. Looking at what’s going on under the hood can highlight areas of economic momentum.
Key Takeaways from the GDP Report
I’ve seen many comments dismissing the report because of the contribution from inventories (+0.8%-points), which tends to be mean reverting. But this was offset by net exports, another number less reflective of core economic strength that also tends to be mean reverting. Final sales to domestic purchasers, which excludes trade and inventories, came in at 2.7%, almost identical to the headline GDP number.
As has been the case for much of the expansion, consumer spending led the way, including a big rebound in goods spending from Q1, when goods spending had actually contracted.
There was a big jump in equipment investment, bolstered by transportation spending (most notably aircraft). Housing spending continues to see a headwind from interest rates and fell for the first time in four quarters. This should get a boost once rates come down.
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Government spending made a solid contribution, with the main contributing factor the investment side of federal defense spending.
Overall, the report does not change our outlook for the economy. While economic risks have risen, we still see a lot of underlying strength. However, with interest rates still restrictive and disinflation continuing, we think the Fed needs to be more focused on risks to employment, even with the strong GDP report. It would probably be appropriate to cut in July, but that’s very unlikely given current messaging and we think we’ll need to wait until September.
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