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Strong Domestic and Foreign Demand Drove GDP Growth to 4.1% in the Second Quarter

The U.S. economy grew at a 4.1% annualized pace in the second quarter, largely in line with consensus expectation (4.2%) and our June forecast of 4.3% growth. A strong expansion in consumer spending, business investment and exports helped drive growth in the quarter.

Real personal consumer spending rose 4% in the quarter after rising just 0.5% in the first quarter (downwardly revised from 0.9% previously). Consumption strength was broadly based across goods and services.

Business investment rose 7.3%, which was stronger than anticipated. A robust increase in structures investment (+13.3%) for the second consecutive quarter helped, as did a firm expansion in intellectual property (+8.2%). Investment in mining exploration, shafts and wells (which includes the shale oil industry) was up 97% annualized, as drilling activity boomed in response to higher oil prices. Equipment investment growth slowed to 3.9% from the 9.4% average pace over the previous five quarters.

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In addition to business investment, fiscal stimulus was also evident in a 3.5% gain in federal government expenditure in the quarter.

Residential investment declined 1.1% in the quarter, the second consecutive quarter of decline.

Net trade contributed a full percentage point to growth in the quarter, driven by a 9.3% rise in exports and a paltry 0.5% increase in imports. Part of this strength reflected a temporary spike in soybean and core shipments to beat out the imposition of tariffs from China. This factor alone added about 1 percentage point to growth in the quarter.

At the same time, with much of the agriculture shipments coming out of stockpiles, a decline in inventory investment shaved roughly an equal amount (about 1 percentage point) off growth in the quarter.

In addition to the usual update of benchmark data, the annual comprehensive revisions this time around included a rebasing of real GDP to 2012 prices, and changes to seasonal adjustment methodology in order to mitigate residual seasonality. Overall,  these changes left annual average growth largely unaffected over the past five years, but the changes to the seasonal adjustment methodology altered quarterly growth profiles by up to a full percentage point.

Key Implications

As expected, the U.S. economy recorded tremendous growth in the second quarter. After such a strong performance, what comes next? Tax cuts and fiscal stimulus spending should continue to broadly support economic activity in the second half of the year. But, trade policy uncertainty has undoubtedly dented business confidence domestically and abroad, possibly leading businesses to delay further investment. As evidenced by the strong export numbers for agricultural commodities earlier in the quarter, tariffs have already acted to distort economic activity. Looking ahead, growth should remain near a 3.0% annualized pace in the second half of the year, but an escalation in trade tensions could push that estimate down.

Given the backward looking nature of the data, today’s report is unlikely to persuade the Fed to alter its plans to gradually normalize monetary policy. We anticipate that the Fed will raise rates twice more this year, bringing the upper end of the target range to 2.5% in December.

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