Despite a strong rebound in consumer spending and a sustained surge in artificial intelligence (AI)-related business investment, the US economy expanded at a notably slower pace in the second quarter, falling short of expectations due to a widening trade deficit and declining inventories. Preliminary estimates from the Bureau of Economic Analysis released on Thursday showed that inflation-adjusted gross domestic product (GDP) grew at a 1.5% annualized rate in the second quarter. This marks a deceleration from the 2.1% growth recorded in the first quarter and was well below the 2.1% consensus forecast from economists. However, after the release of leading economic indicators, some economists had already lowered their forecasts to as low as 1.5%, leaving the final data in line with the revised expectations.
The relatively weak headline GDP figure largely masks the resilience of US domestic demand. Consumer spending, which accounts for more than two-thirds of US economic activity, was a standout performer in the second quarter, accelerating sharply to a 3.2% annualized growth rate from 0.5% in the first quarter. This robust recovery was supported by several one-off factors. Households received more generous tax refunds this year, thanks to the "One Big Beautiful Bill" championed by former President Donald Trump, which helped cushion the impact of higher gasoline prices driven by Middle East conflicts on purchasing power. Additionally, a temporary decline in gasoline costs at the end of the quarter, increased retailer promotions, and spending related to the recently concluded World Cup and midterm elections by non-profit organizations all contributed to stimulating consumption. In June, inflation-adjusted consumer spending rose 0.4% month-over-month, matching the highest single-month increase since July 2025. Household spending growth was driven primarily by durable goods such as furniture and motor vehicles. On the services side, consumers increased spending on discretionary categories like entertainment, dining, and accommodation.
Meanwhile, business investment remains a core pillar of economic growth. In the intense race to dominate AI, tech giants continued to spend heavily, ignoring investor concerns about overvaluation. Major technology companies like Meta (META.US) and Microsoft (MSFT.US) significantly expanded investments in data centers during the second quarter, accelerating the buildout of AI infrastructure. Additionally, demand for industrial and transportation equipment contributed notably. Federal Reserve Chair Kevin Warsh described the economy's resilience as "impressive" following the Fed's meeting on Wednesday, highlighting that the most "striking" feature of the economy is the strength of business investment. Since trade fluctuations often distort headline GDP figures, economists closely monitor a more accurate measure of domestic demand that excludes trade, inventory changes, and government spending: final sales to domestic private purchasers. This indicator climbed 3.9% in the second quarter, more than double the pace of the first quarter, marking its strongest performance since early 2023 and further confirming that the foundation of the US economy remains solid.
From the perspective of GDP components, foreign trade and inventory changes were the primary drags on growth. Net exports subtracted a full 1 percentage point from GDP in the second quarter. This reflects both companies rushing to import goods ahead of new tariffs taking effect and a surge in demand for capital goods. Inventory changes further reduced GDP by approximately 0.67 percentage points, indicating that many businesses opted to draw down stockpiles during the six-month conflict with Iran. Non-residential fixed investment grew at an annualized rate of 8.4%. Within this, industrial equipment investment posted its largest increase since 2011, and transportation equipment investment recorded its highest growth in two years. Investment in information processing equipment and software continued to grow, though at a slower pace.
Despite strong domestic demand, the shadow of war is gradually eroding the economic outlook. With the resurgence of conflict in the Middle East, the national average gasoline price has climbed back above $4 per gallon. Against a backdrop where wage growth is barely keeping pace with inflation, US households are being forced to draw on savings or lower their savings rate to maintain current consumption levels. Economists have warned that this consumption pattern may be unsustainable in the face of rising economic uncertainty, predicting that households may soon shift toward precautionary saving, which would weaken the economy's most solid pillar of domestic demand and pose downside risks to the US economy in the second half of this year.
On the inflation front, data released the same day showed that the Federal Reserve's preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, fell 0.1% month-over-month in June, the first decline since 2020. This price drop was primarily driven by lower international oil prices following a temporary ceasefire agreement between the US and Iran. On a year-over-year basis, the inflation rate eased to 3.7% from a three-year high of 4.1% in the previous month. Excluding energy prices, the core inflation index rose 0.1% month-over-month in June, a smaller increase than market expectations. Over the 12 months through June, the core PCE year-over-year rate fell to 3.3% from 3.4% in the prior month. However, price pressures from geopolitical tensions have not disappeared. The decline in June was mainly due to lower oil prices following the start of peace talks between the US and Iran. But significant disagreements remain between the two sides, keeping oil prices relatively high. The inflation rate could remain above 3% through the end of the year, putting pressure on the Federal Reserve. The Fed voted on Wednesday to keep its benchmark overnight interest rate unchanged in the 3.50%-3.75% range, but the decision saw an unusual three dissenting votes, with members "preferring" a 25-basis-point rate hike at this meeting. In its statement, the Fed said economic activity was expanding at a solid pace despite high uncertainty stemming from the Middle East conflict. The Fed views the PCE price index, especially core PCE, as the most accurate measure of US inflation trends. The indicator shows inflation has been well above the central bank's 2% target for six consecutive years. Market analysts expect the Fed may resume raising rates as early as September to fully curb inflation, casting a shadow over the growth outlook for the second half of the year.
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