The U.S. economy continued its cautious expansion through the quarter, despite mixed signals from key indicators. GDP grew at an annualized rate of 3.8% during the second quarter, reflecting the fastest growth rate in nearly two years.
Much of the growth was driven by trade dynamics, with a sharp drop in imports causing net exports to contribute 4.83% to GDP growth. This was essentially the reverse of the prior quarter, when companies rushed to stockpile inventory ahead of tariff deadlines, resulting in a 4.68% drag on GDP. For reference, trade contributions to GDP had not exceeded 1% since the pandemic. Given the magnitude of these shifting import trends and their effect on the headline figure, understanding the underlying data is critical to accurately assessing the economy’s true health.
Consumer spending remained positive while showing signs of diverging spending patterns and sentiment depending on the income cohort. Making up approximately two-thirds of GDP, consumer activity grew at an annualized rate of 2.5%, largely driven by high-end goods and services. The strength of upper-income household spending was highlighted in a recent Moody’s report which revealed the top 10% of American earners now account for 50% of economic spending.
Meanwhile, lower- and middle-income households have become more cautious amidst higher prices, borrowing costs, and uncertainty. Consumer confidence in those income groups fell to their lowest levels since April, according to a University of Michigan survey. As such, the consumer landscape remains active, but increasingly reliant on high earners as broader demand cools. Maintaining positive wage growth across income levels will be critical in sustaining consumer sentiment and spending.
The labor market lost some of its momentum, showing signs of weakness. The private sector lost 32,000 jobs in September, a figure that came well below expectations and one that represents the third month of private-sector job losses since June. At the time of this writing, the Bureau of Labor Statistics (“BLS”), whose reports include government workers, had not yet released their data due to the government shutdown. Expectations are muted as the Trump administration’s deferred-resignation deal took effect for many government workers last month. As a reminder, federal workers were offered compensation packages in exchange for their voluntary resignations. Of the approximately 154,000 workers who took the deal, two-thirds were set to come off the government’s payroll in September, adding to the softening labor market.
The delayed BLS report will be critical for the Federal Reserve, who cited a weakening labor market as their primary reason to cut the federal funds rate from 4.25% to 4.00% in September. There are still expectations of two more rate cuts before the end of the year. However, Fed Chair Powell indicated that the Fed must walk a fine line between supporting the labor market and fostering continued progress against inflation.
Elsewhere, business spending was strong due to a surge in investment in information processing equipment and software used in the buildout of infrastructure related to AI, which signals growth in one area of the economy that will be increasingly important.
Back in Washington, the federal government shutdown continues as lawmakers hit an impasse on funding talks. While shutdowns can have direct economic implications, the extent of the damage largely depends on their duration. Each week of closure is estimated to cost the economy approximately $7 billion and trim GDP by 0.15%. A closure’s impact is primarily driven by a lack of federal spending, delayed contracts, and unpaid government workers who lose spending power. Nearly 600,000 federal employees are currently furloughed with another 700,000 deemed essential and therefore working without pay. Regardless, a portion of the economic cost is typically reversed when the government reopens, as furloughed workers receive back pay and federal contracts are reactivated.
While near-term volatility appears likely given these crosscurrents, the underlying fundamentals suggest the economy has retained sufficient momentum to navigate the challenges ahead, albeit at a more measured pace than the headline GDP figures might suggest.
