A near Goldilocks report on growth

Real GDP growth accelerated from a 2.0% annual pace in the first quarter to a 2.4% pace in the second quarter. Consumer spending moderated but not as much as expected. Spending on services held up better than spending on goods, which slipped below 1% in the second quarter. The housing market contracted for its ninth consecutive quarter but showed signs of bottoming. Single-family housing starts and new home sales rose during the quarter as builders offered mortgage buydowns to boost demand.

Business investment, which fell into the red last quarter, rebounded in the second quarter. Incentives for chip and EV plants are buoying investment in both structures and equipment. Durable goods orders for June suggest that momentum will be carried forward, despite weakness in overall manufacturing and the freight sector, where bankruptcies are on the rise. Inventories moved up slightly after draining rapidly in the first quarter.

The outlier was trade, which acted as a slight drag on growth; exports fell more rapidly than imports. Earlier dollar strength and weakness abroad accounted for the sharp, double-digit drop in exports. Those losses were driven by a drop in goods exports. Service sector exports, which include foreign travel to the U.S., picked up during the quarter. The loss in imports was less but still large, down 7.8% after a slight rise in the first quarter. The losses in imports were in both goods and services.  

Government spending slowed to almost half the pace of growth of the first quarter. Federal spending was hit much harder than spending at the state and local levels, which remained buoyant. The slowdown in federal spending was driven by a drop in nondefense spending, which included the giveback after the first quarter surge in Social Security payments. State and local spending remained much stronger with earlier funding for infrastructure improvements, including that allocated for schools during the pandemic.

Separately, the GDP deflator, which is a measure of overall inflation, slowed to its weakest annual pace since the second quarter of 2020. The slowdown in the costs of investments was greater than that for consumer spending, but both moved in the right direction. The PCE (Personal Consumption Expenditures) index, which the Federal Reserve targets, slowed to a 2.6% annual pace, its weakest since the fourth quarter of 2020. 

Today’s data have important implications for the data to be released tomorrow on inflation, as it suggests that the PCE measure of inflation increased only 0.1% in June, half of market expectations. That will bring the year-on-year measures of the PCE index down to 2.9% instead of the 3% expected. The core PCE measure appears as though it came in below expectations in June with an increase of 0.1%. That will take the core PCE down to a 4% increase on a year-over-year basis. That is still double the pace the Fed would like but moving in the right direction.

Federal Reserve Chairman Jay Powell was careful to caution against making too much of the current improvement in inflation. One month does not a trend make; some components of inflation, notably prices at the gas pump, are moving up again.