United States: Economy cools in Q2, but resilient consumer spending softens the slowdown
The economy slowed in the second quarter, but fared better than expected, buttressed by strong household spending and a rebound in government consumption and investment related to the government shutdown in Q1. Nevertheless, contracting business fixed investment and a drag on growth from the external sector highlight diverging trends in the economy. According to an advance GDP estimate released by the Bureau of Economic Analysis, GDP expanded 2.1% in Q2 over the previous quarter in seasonally-adjusted annualized terms (SAAR), slowing from the 3.1% expansion registered in Q1 2019, but surpassing market expectations of 1.9%. In annual terms growth ticked down to 2.3% in Q2 from 2.7% in Q1.
The star performers of the report were consumers, with private consumption expanding 4.3% SAAR in Q2 (Q1: +1.1% SAAR) amid a tight labor market, still-elevated consumer confidence, and lower gasoline prices in the quarter. Moreover, government expenditure growth accelerated in the second quarter (Q2: +5.0% SAAR; Q1: +2.9% SAAR) driven by robust federal expenditures, largely due to pent-up spending caused by the government shutdown that restrained outlays in Q1.
Investment, for its part, showed serious weakening in the second quarter. Fixed investment contracted 0.8% in Q2 (Q1: +3.2% SAAR), weighed on by a dip in nonresidential investment, which includes business spending on structures, equipment and software. Meanwhile, residential investment continued to decline for the sixth quarter running in Q2 amid a feeble housing market. Private inventory drawdown also dragged on growth, in contrast to the inventory buildup seen in Q1, partly the result of soaring consumer demand.
Turning to the external sector, exports of goods and service dropped sharply in Q2 (Q2: -5.2% SAAR; Q1: +4.1% SAAR), while growth in imports of goods and services recovered in the quarter (Q2: +1.5% SAAR; Q1: -0.1% SAAR). Consequently, net trade detracted 0.7 percentage points from growth in Q2, offsetting the 0.7 contribution in Q1. Imports and inventories have seesawed in recent quarters amid the uncertain outlook for U.S. trade policies with China.
Looking ahead, economic growth is expected to cool further and will likely continue to paint a mixed picture of the health of the economy. Resilient household spending should continue supporting growth, while business investment will likely rebound in Q3, partly thanks to a low base effect. However, the Q2 report revealed heightened caution among businesses in the wake of the persistent U.S.-China trade dispute, and the growing downside risks to the external sector. The Federal Reserve will likely focus on these growing weaknesses at its FOMC meeting on 30–31 July and the vast majority of FocusEconomics panelists have penciled in an “insurance” rate cut to buffer the nascent slowdown.
Commenting on ING’s outlook for the Fed meeting, chief international economist James Knightley, explained:
“Given that the volatility in trade and inventories had such a huge impact on both [Q1 and Q2] GDP growth, we think it’s better to look at the two quarters together. This gives an average rate of 2.6%, which is clearly very respectable. […] Nonetheless, the run rate for growth is slower than the 3% seen in much of 2018 and there is the threat that trade uncertainty will continue to act as a brake on activity. To combat this risk, we expect the Federal Reserve to pull the trigger on a precautionary 25bp rate cut next Wednesday with a further 25bp move likely in September.”