Q1 GDP falls short of expectations

April 30, 2026

Real GDP improved to 2.0% annualized growth in the first quarter from 0.5% in the fourth quarter. The outcome was slightly below market expectations of 2.3%. The GDP deflator, a measure of inflation, rose 3.6% after rising 3.7% in the fourth quarter.

Consumer spending contributed half of the strength in economic activity, rising 1.6% after growing 1.9% in the prior quarter. Spending was uneven as services expanded 2.4% while goods consumption slipped 0.1%. Higher tax refunds provided a cushion for consumers to spend although this will run out soon. 

Business investment surged 10.4%, the fastest pace since the second quarter of 2023. Equipment spending soared 17.2%, the strongest in a year, aided by the investment boom in data centers. Front-loaded ordering provided a boost because the longer the Strait of Hormuz remains closed, the wider the supply chain disruptions. A shortage of helium, a necessary component in semiconductor chip production, could constrain chip availability needed for AI applications. The pickup in equipment spending and intellectual property, up 13%, helped offset a decline in structures, down 6.7%.

The losses in residential investment deepened in the first quarter. Housing investment fell 8%, the fifth consecutive quarter of decline and the largest drop since the fourth quarter of 2022. The spring selling season appears to be another bust. Mortgage rates have risen on the back of higher Treasury yields over inflationary concerns linked to the Iran war. This has resulted in reduced refinancing activity and locked potential home buyers out of the market.

Deja-vu for a different reason. For the second consecutive year, there was a pop in inventories and the trade deficit in the first quarter ahead of supply chain concerns. Inventories added 0.4% on the back of preemptive building of stocks to insulate against future shocks. Last year, inventory building made a strong contribution in the first quarter ahead of tariffs.

For the same reason, the trade deficit widened as imports rose at a faster growth rate of 21% in the first quarter while exports grew 13%. Imports for high-tech goods continued to climb as many are inputs for data center construction and exempted from tariffs. This category made its highest contribution to date since the data began being collected in 1972.

Government spending rebounded after falling in the previous quarter due to the six-week federal government shutdown. Government spending rose 4.4% in the first quarter after contracting 5.6% in the fourth quarter with the federal component being the key swing factor. Federal spending rose 9.3% while state and local spending increased 1.6%.

Inflation heating up again

The personal consumption expenditure (PCE) index, the Federal Reserve’s favored inflation measure, rose by 0.7% in March, accelerating from 0.4% in February. The year-over-year increase in the PCE index came in hot at 3.5% from 2.8% in February. That is the fastest pace of inflation since May 2023.

Core PCE, which strips out the energy and food components of the index, rose 0.3% after gaining 0.4% in February. Core inflation picked up to 3.2% from a year ago in March compared to an annualized 3.0% in February. The bite of higher inflation resulted in a slowing in real consumer spending to 0.2% in March from 0.3% in February.

The three-month annualized pace in the personal consumption expenditures price index (PCE) index rose to 5.6% from 4.2% in March. For core inflation, it rose 4.4%, near the 4.6% pace in February, effectively the highest since March 2024. Those figures better capture momentum; all are headed in the wrong direction for the Fed.

Core goods inflation rose 0.2% after rising 0.8% in February. It rose 2.8% annually, up from 2.3% in February.

The super core services, which strip out energy services and shelter, increased 0.3% after rising 0.2% in February. That translates to a 3.4% increase from a year ago, close to where it has been for much of the year. That is still more than a full percentage point above where it was before the pandemic and appears to be sticky. That is a problem for the Fed, as it is harder to get inflation down to its 2% target, without service sector inflation cooling.