US reaction: Q2 GDP: a little faster, not too slow

Headline US GDP growth rose by 2.8% (saar) in Q2 – twice the pace of the previous quarter. This was above our expectation for GDP growth of 2.0% (and consensus for the same), but in line with the Federal Reserve of Atlanta’s GDP now tracker, which rose to 2.7% after June’s retail sales rebound and revisions.

Consumer spending drove much of Q2’s increase, rising by 2.3% on the quarter, faster than the consensus estimate of 2.0% and suggesting a stronger increase in real consumer spending in tomorrow’s report for June (or revisions to previous months). Spending accelerated from Q1, where it rose by just 1.4%. However, the pace of spending has indeed slowed from the strong pace over H2 2023, where it averaged 3.2%, and the average pace for 2023 as whole (2.7%) to average just 1.9% in H1 2024. But Q2’s report was also stronger on other counts: government spending quickened to 3.0% from 1.8% in Q1. Total investment spending came in firmer than we expected at 3.6%, although this was slower than the 6.8% posted last quarter. The slowdown reflected a drop in residential investment, which fell back in Q2 after a sharp rise in Q1 following sharp interest rate declines in the preceding quarter. However, Q2’s fall was somewhat less than we had forecast. Moreover, business investment accelerated to 5.1% from 4.4% in Q1, likely reflecting ongoing tailwinds from government policies. Finally, inventory surprised again, posting a modest rise (and adding 0.8ppt to Q2 GDP), compared with our forecasts of a fall.  

In total, GDP continues at a decent clip and after today’s release we raise our GDP forecast to 2.5% (from 2.3%). But it has slowed in headline terms – halving to 2.1% in H1 2024 compared with 4.1% in H2 2023 and to 2.5% from 3.5% for domestic final sales (excluding the more volatile trade and inventory measures). This softening is not pernicious, indeed we believe that it is consistent with the economy achieving a soft landing. But growth is probably below the migration-augmented potential rate at the moment, consistent with the Federal Reserve returning inflation to target over the forecast horizon.

We argue that today’s release should go some way to allaying the concerns that have been building around the softening economy. In recent days prominent commentators including ex-New York Fed President Bill Dudley have suggested that the Fed should cut rates in July. We do not consider such an urgent need. Even following several days of equity sell-off that have tightened financial conditions materially, overall – and based on an assumption that the Fed will cut rates twice this year in September and December – conditions are around the loosest that they have been since August 2022 and similar to pre-pandemic levels. We expect the Fed to be comfortable with today’s release – soft enough to suggest inflation should continue to fall, firm enough to avoid concerns about a downturn. And on our forecasts this should see the Fed ease rates in September.    

Financial markets responded to the release. Short term rate expectations had been pricing in an over 10% chance of a 0.50% Fed Fund cut in September and over 70% chance of 3 cuts by year-end. These expectations have retreated to fully pricing September, but still a more than 50% chance of three cuts. Accordingly, 2-year US Treasury yields rose by 5bps to 4.44% and 10-year yields were up 4bps to 4.25%. The dollar also increased by 0.1% against a basket of currencies.