United States: Q2 GDP growth at four-year high on strong consumer spending, tax cuts and tariff anticipation effects
An advance GDP estimate showed the U.S. economy firing on all cylinders in the second quarter, supported notably by an acceleration of private spending, coupled with a strong export performance—partly due to the front-loading of activity in anticipation of tariffs which took effect in early July. GDP growth in the second quarter reached a four-year high of 4.1% in seasonally-adjusted annualized (SAAR) terms, significantly up from the revised 2.2% figure recorded in Q1 (previously reported: 2.0%). It should be noted that the revised Q1 GDP data benefited from methodological improvements by the Bureau of Economic Analysis, which better account for residual seasonality effects; these effects were previously responsible for growth being understated. Despite the strong Q2 performance, the growth print slightly undershot market expectations of 4.2%, as many analysts had anticipated “one-off” effects such as tax cuts—the effects of which are expected to wane in 2019—and a surge in exports ahead of incoming tariffs. In year-on-year terms, the economy expanded 2.8% in Q2, up from 2.6% in Q1.
Private spending surged to 4.0% annualized growth, after a weak first quarter saw growth of only 0.5% due to a contraction in goods purchases. Private expenditure growth was the largest contributor to the headline growth print in Q2, driven by an ever-tightening labor market and the effects of tax cuts enacted in December 2017—which usually take some time to fully take effect on private expenditures. Spending on goods surged in Q2 after contracting in Q1 thanks to higher durable goods purchases, including notably a rebound in sales of motor vehicles and parts. Meanwhile, service spending growth logged its best performance in over three years, primarily supported by spending in essential services: healthcare, accommodation and housing, utilities, and food services. Finally, public spending also accelerated following the lifting of spending caps in Q1, mainly on the back of a sharp increase in military expenditures.
Residential investment continued to be a weak point of the U.S economy in the second quarter, although it stabilized from Q1 (-3.4% SAAR), contracting 1.0% in annualized terms. Non-residential fixed investment, on the other hand, remained robust (+7.3% SAAR) but still decelerated markedly from the 11.5% surge recorded in Q1, as firms moderated their spending on equipment and intellectual property products. Meanwhile, inventories depleted sharply in the quarter, subtracting a full percentage point from the headline GDP growth; this was in anticipation of incoming U.S. tariffs—and the consequent retaliation by its trade partners—which pushed many firms to front-load their activity. However, this bodes well for GDP growth in the third quarter, as inventories would likely need to be rebuilt.
The prospects of tariffs also had a significant effect on the external sector in Q2, as firms rushed to conduct international business and ship production ahead of the 6 July deadline for the bulk of tariffs—notably between the U.S. and China—to take effect. Exports consequently surged in Q2 (+9.3% SAAR; Q1: +3.6%), driven entirely by exports of goods, while service exports moderated. Import growth softened to just 0.5% annualized (Q1: +3.0%) due to a contraction in service imports. This led the external sector to contribute 1.1 percentage points to GDP growth, its best performance since Q4 2013.
Despite the stellar second quarter, many analysts see growth moderating in H2 2018 as global headwinds mount. Most crucially, the upending of the global trade order by the Trump administration is fanning uncertainty. This is likely to weigh on business confidence and investments as industrial firms may reconsider their long-term strategic planning—notably the location of their operations to circumvent the effect of tariffs. Furthermore, recent months have shown weaker growth in the Eurozone and China, which could impact the external sector. Nevertheless, the rapid pace of growth of the U.S. economy, which some observers see at risk of overheating, should for now comfort the Federal Reserve in its probable plan to raise rates two more times this year, and makes it likely the economy will reach its growth forecast.