“Now, the Fed’s efforts to cool the economy are having a visible effect. Granted, wealthy households are still consuming, thanks to buoyant asset prices and mortgages refinanced at historically low long-term rates,” Dudley wrote. “But the rest have generally depleted what they managed to save from the government’s huge fiscal transfers, and they’re feeling the impact of higher rates on their credit cards and auto loans.”
Nothing in the second quarter’s GDP report supports the idea that “the rest” of American households have
depleted their spending power
or are being held back by higher rates on credit cards and auto loans.
To the contrary, of the best indicators of the strength of private sector demand maintained a solid pace of growth in the second quarter.
Final sales to private domestic purchasers
grew 2.6 percent for the second consecutive quarter, putting the growth for the first half of 2024 right in line with the growth in the first half of 2023.
We can see another sign of rising business confidence in
inventory growth
. As anticipated, inventories rebounded in the second quarter, contributing 0.8 percentage points to growth after being a drag in the first quarter. Meanwhile, net exports detracted from growth, shaving off 0.7 percentage points. These volatile elements effectively canceled each other out.
Exports grew by 2.0 percent, but imports surged by 6.9 percent
—fueled by strong household consumption and business investment.
Dark Clouds in a Sunny Report
There were some parts of the report that are not as good news.
Residential investment fell
in the second quarter following three consecutive quarters of growth, likely reflecting
the drag of high interest rates
but also the surge of building last year that has left
homebuilders with more inventory
than they would like. The threat of lower interest rates bringing existing homes on to the market, lowering demand for new homes, may also have slowed down building.
Nonresidential structures investment fell by 3.3 percent.
This category saw double-digit growth rates last year thanks to fiscal policies aimed at boosting
high-tech factory construction
. That growth raised construction employment and allowed the Biden-Harris administration to claim that America was experiencing a manufacturing boom. The contraction in the second quarter indicates that some of this growth was actually borrowed from the future. As a result, this may remain weak in future quarters now that
fiscal support has run its course
.
An unwelcome development was a 3.1 percent rise in government consumption. This was driven by a surge in federal spending, especially
in the defense sector
, where consumption surged 5.2 percent. This suggests that
War Keynesianism
is playing too large a role in boosting growth—and may be draining real resources that could be used in other sectors of the economy. What’s more,
building rockets that get used in foreign wars does not add to national wealth
in the way that domestic investment or consumption does.
Finally,
core personal consumption expenditure inflation
came in at a higher-than-expected 2.9 percent seasonally adjusted annualized rate. This either means that there will be upward revisions to the softer inflation prints for prior months or that the June inflation figure, due out tomorrow, will come in higher than forecast.
The Facts Change, But Rate Cut Opinions Stay the Same
The much higher-than-expected rate of economic growth and higher inflation rate has
not shaken Wall Street’s faith
that the Fed will cut in September–although it did choke off the small hope that the Fed could cut in June. There’s more than a hint of
irrationality in the fixation on a September cut
. More growth means less urgency to cut, and more inflation means more upside risk to inflation from a cut, which should translate into a paring back of rate cut expectations.
The rosy-interpretation being passed around by Wall Street analysts on Thursday is that this report bolsters the case for the
soft-landing scenario
, in which inflation falls back to target without a downturn. That is somehow supposed to lead to a series of Fed cuts that keep asset prices rising without triggering inflation at the consumer level.
That’s still a possible outcome, but we think this report makes it less likely. Instead,
we see an economy that remains resistant to the Fed’s attempt to slow things down
and indications that the stance of monetary policy is far less restrictive than the Fed supposes. That, in turn, raises the risk that to bring down inflation, monetary policy will have to tighten further, either through a rate raise or a renewed commitment to keep rates higher for longer.
Wall Street has been wrong about the economy for four years running.
It thought inflation would be transitory in 2021, it underestimated the Fed’s response in 2022, it was convinced that the Fed’s hikes would cause a recession in 2023, and it entered this year expecting five cuts. Why should we expect it to start getting things right now?
The problem is that
the Fed has been wrong almost as often
, raising the risk of a policy mistake—in the form of a premature rate cut this year—that winds up fueling inflation.