The recent release of the U.S. economic growth data (Gross Domestic Product or GDP) has surprised economists with an upside surprise. The economy expanded at an annualized pace of 2.8% in the second quarter, far exceeding expectations of 2% and a significant jump from the first quarter's 1.4% growth.
Powering the Economy: Consumers Defy Expectations
Businesses Bolster the Rebound
The economic growth was a collaborative effort, with businesses restocking inventories, investing in equipment, and the government increasing its spending. However, the most significant driver was consumer spending, which accounts for nearly 70% of the economy. Consumers opened their wallets for healthcare, housing, cars, auto parts, and furnishings, defying expectations and fueling the unexpected expansion.
Cautious Optimism: Potential Revisions Ahead
While the positive report is encouraging, it's important to note that the growth rate may be trimmed when the second and third versions of Q2 GDP are released in the coming months. Additionally, some of the upside surprise can be attributed to transportation companies ramping up their spending in June to make up for equipment production problems earlier in the year.
Wealthy Consumers Lead the Charge
The pace of consumer spending continues to confound economists. It's evident that wealthier Americans are driving much of the spending in the post-pandemic era. This group has seen their home values and investments increase dramatically over the past five years, and they have also benefited from the rise in interest rates, locking in low, fixed-rate mortgages during the pandemic and subsequently enjoying higher interest rates on their safe money.
Middle-Class Consumers Contribute to the Surge
However, the total consumer spending cannot be solely attributed to the wealthy. Middle-income and lower-income Americans are also participating in the spending surge. Many of these individuals have spent down their pandemic savings amid higher prices, but they are able to keep the spending spigots open for two reasons: their wages are now outpacing the inflation rate, and they are increasingly turning to credit cards and running up balances.
Labor Market Resilience: A Double-Edged Sword
As long as the labor market remains firm, those in debt should be able to keep up with their spending. Overall, job growth has been better than expected this year, with the economy producing an average of 222,000 jobs per month in the first half of the year. However, there is an expectation of a slowdown in the second half as companies downshift their hiring plans. Economists are also closely watching wage growth, which has been slowing, as well as credit card and auto delinquencies, which have been rising, as early signs that consumers may retrench later this year.
The Fed's Dilemma: Balancing Inflation and Growth
The Federal Reserve's decision-making process is a delicate balancing act. In his recent testimony before Congress, Fed Chair Jerome Powell stated that the Fed needs "more good data" before cutting rates. San Francisco President Mary Daly echoed this sentiment, saying that despite an improvement in inflation readings, "we're not there yet."The definition of "good data" is crucial. The most recent release of the Fed's preferred gauge of inflation, the Core PCE Index, showed that the 12-month annual core inflation rate remained unchanged at 2.6%, but the three-month annualized rate dropped to 2.3%, from 2.9%. This indicates that price increases are slowing down, a process known as "disinflation."If the inflation rate continues to trend lower this summer, as most economists believe, and the job market remains resilient enough to keep consumers afloat, Federal Reserve officials could target their September meeting for the first rate cut of the cycle, providing much-needed relief to American borrowers.
