Source: Jinshi Data

The U.S. economy is likely to continue growing in the second quarter, driven by solid consumer spending and inventory builds, but the pace of expansion should still keep expectations for a September rate cut by the Federal Reserve intact. In addition, other data are expected to show that U.S. inflation slowed sharply last quarter, with all measures below 3%, good news for Fed officials.

The U.S. economy is outperforming its global peers despite aggressive interest rate hikes by the Federal Reserve in 2022 and 2023, and the labor market remains resilient even as the unemployment rate rises to 4.1%, the highest level in 2 1/2 years.

“The expansion is meeting the ‘Goldilocks’ expectations, where growth is slowing, inflation is falling and consumer spending is driving the economy,” said Brian Bethune, an economics professor at Boston College.

A Bloomberg survey of economists showed that U.S. GDP may have grown at an annualized rate of 2% last quarter, slightly higher than the 1.8% non-inflation growth rate that Federal Reserve officials believe.

However, the survey was conducted before data on Wednesday showing a narrowing of the U.S. trade deficit in June and increases in retail and wholesale inventories. The data prompted the Atlanta Federal Reserve to cut its second-quarter GDP growth forecast to 2.6% from 2.7%.

The U.S. economy grew 1.4% in the first quarter. Still, the rate of growth would be significantly lower than the 4.2% recorded in the second half of last year.

Consumer spending, which accounts for more than two-thirds of the U.S. economy, is expected to grow at a roughly 2% pace in the second quarter after slowing to a 1.5% pace in the first quarter, with most of the gain coming in June.

Businesses have accumulated more inventories, and economists estimate that inventories may add at least one percentage point to GDP growth after dragging on it for two straight quarters. While inventories are expected to boost the economy, economists expect domestic demand to grow at a pace of around 2.4%.

The GDP growth forecast foreshadows an acceleration in productivity, which will slow the pace of labor cost increases and ultimately ease price pressures. U.S. core PCE is expected to slow to 2.7% in the second quarter after surging at a 3.7% pace in the first quarter.

The GDP deflator, the broadest measure of prices in the U.S. economy, is expected to increase 2.6% after jumping to 3.1% in the first quarter.

Trade deficit drags down US GDP

"It's very possible that inflation will be more important than the actual growth number," said Dan North, senior economist at Allianz Trade North America.

The Fed has kept its benchmark overnight rate in its current range of 5.25% to 5.50% over the past year.

The Fed has raised its policy rate by 525 basis points since 2022, and slowing inflation, combined with a cooling labor market, will boost financial market expectations for three rate cuts this year starting in September.

Business spending on equipment is expected to accelerate after modest growth in the first quarter. Government spending is also expected to contribute to growth, but trade is likely to be a drag on growth as exports weaken amid slowing global demand and a stronger dollar.

Pantheon Macroeconomics estimates that the trade deficit will drag down GDP growth by 1.4 percentage points, which would be the largest drag in more than two years. Inventory growth may offset the negative impact on GDP. A surge in mortgage rates in the spring may have undermined the recovery in the housing market.

Residential investment, which includes homebuilding and sales, is expected to have contracted after rising by double digits in the first quarter.

The U.S. economic outlook for the second half of the year is uncertain , despite expectations of faster growth. The labor market is slowing, which will weigh on wage growth. The savings rate is well below pre-pandemic averages, and economists estimate that most of the Fed’s rate hikes have yet to be felt. State and local government revenues are also slowing, which could erode spending.

Others worry about new tariffs and that businesses might bring forward imports if former President Donald Trump returns to the White House in November's presidential election.

Despite this, economists do not expect a recession in the United States and the Federal Reserve to cut interest rates. Ian Shepherdson, chief economist at Pantheon Macroeconomics, said:

“Changes in corporate borrowing costs for small and medium-sized enterprises have historically taken about two years to dampen GDP growth, suggesting that the impact of the Fed’s rate hike cycle, which ended just 12 months ago, has largely yet to be felt, with GDP growth expected to slow to a range of 1% to 1.5% in the second half of the year.”

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