GDP slows to 2.1% in second quarter but beats expectations thanks to strong consumer

Key Points
  • GDP rose 2.1% in the second quarter, down from 3.1% in Q1.
  • The growth was better than Wall Street estimates for a 2% gain.
  • Consumer expenditures rose 4.3% while business investment slumped 5.5%.
US GDP up 2.1% in second-quarter, down from 3.1% the first-quarter
US GDP up 2.1% in second-quarter, down from 3.1% the first-quarter

Growth decelerated in the second quarter, but not by as much as Wall Street thought, as tariffs and a global slowdown weighed on the U.S. economy, the Commerce Department reported Friday.

GDP increased 2.1%, down from the first quarter's 3.1% and the weakest increase since Q1 of 2017 when President Donald Trump took office. Dow Jones Q2 estimates were for 2% growth.

However, the underlying numbers in the report seemed to take steam out of the recession fears that have been much of the talk among economists and policymakers at the Federal Reserve.

"The recession talk was always overstated," said Michael Arone, chief investment strategist at State Street Global Advisors. "Those that were doing the Chicken Little, the sky is falling, we're headed for recession talk were clearly early in that assessment. The economic data continue to suggest that the economy isn't near recession, at least in the next year or so."

Trump himself deemed the report "not bad" and noted that growth was continuing despite what he considers overly tight monetary policy from the Federal Reserve.

Trump tweet

The president's top economic adviser Larry Kudlow expressed similar sentiments in a CNBC interview.

"I think it's almost a miracle that the economy is growing as rapidly as it is," Kudlow said on "Squawk on the Street." "This has not been easy with seven rate hikes."

Consumer and government spending helped propel GDP in the April-to-June period, while a pullback in business investment weighed on the number. Personal consumption expenditures rose 4.3%, the best performance since the fourth quarter of 2017. Government consumption expenditures and gross investment rose 5%, the fastest pace since Q2 of 2009 as the economy was coming out of the Great Recession.

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At the same time, gross private domestic investment tumbled 5.5%, the worst since Q4 in 2015 as spending on structures slumped 10.6%. The decline pulled a full percentage point from the final GDP number. Falling inventories also acted as a 0.86 percentage point drag.

Worries over the back-and-forth tariff battle between the U.S. and China have been a major driver of business sentiment, with executives expressing concern, both in surveys and earnings calls.

The GDP report comes amid growing concern that the weakening growth hitting much of the world's economy is spilling over into the U.S. While consumer activity has been strong, manufacturing growth has slumped recently and housing remains a weak spot.

"The data clearly shows signs of a bifurcated economy. Weakness in manufacturing has weighed on components like inventories and fixed investment, but the healthy U.S. consumer has helped buoy the economy as seen in the stable reading on personal consumption expenditures," Michael Reynolds, investment strategy officer at Glenmede, said in a note. "Altogether, robust domestic consumers are more than offsetting the headwinds of a weakening manufacturing economy."

Economic advisor Larry Kudlow on the economy and GDP growth
Economic advisor Larry Kudlow on the economy and GDP growth

The rise in consumption will need to continue for an economy that has fallen short of Trump's promise for 3% growth that was supposed to be carried by the $1.5 trillion tax cut approved in 2017.

In addition to tallying up the most recent progress, Friday's report also featured revisions for the past five years. The new figures showed that GDP still rose 2.9% in 2018 when comparing total output over the year, though another measure called real GDP, comparing the fourth quarter of 2018 from the same period in 2017, showed an increase of just 2.5%, a decline from 2.8% in 2017.

"We had a big personal consumption number that's not going to be sustainable going forward," said Joseph Brusuelas, chief economist at RSM. "The brief period of 3% growth is in the rear-view mirror. The economy's decelerating, but it's not going to end up in recession."

Fed policymakers have been expressing concern about a potential slowdown and are expected to approve a quarter percentage point rate cut at their policy meeting next week. The Fed currently targets its benchmark funds rate in a range between 2.25% and 2.5%, but markets are pricing in a 100% chance of a cut and about a 53% probability of two more reductions before the end of the year, according to the CME.

While central bankers worry over rates, corporate profits have proven more resilient than expected, and analysts believe the economy, though slowing, remains strong enough to support earnings. Also, Goldman Sachs said in a report earlier this week that recent economic data is showing improvement, and the bank's strategists expect GDP to rebound to around 2% in the second half.

Markets were still expecting the Fed to cut, through the probability of a 50 basis point reduction fell to 19% following the GDP report from about 24% earlier in the morning.

"The net on this is that given the Fed's global reasons to ease and that market strength and hence consumption are similarly built on the expectation of lower policy rates the Fed has no option other than to cut 25 on Wednesday and see whether the data unfold to create the need for a further cut in September," said Steve Blitz, chief U.S. economist at TS Lombard.