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What's Next for U.S. GDP After Best Quarter of Growth Since 2014

Gains in consumer, and business demand fueled the American economy’s 4.1 percent growth in the second quarter.

What's Next for U.S. GDP After Best Quarter of Growth Since 2014
A magnifying glass is held over a 50 subject one dollar note sheet in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)

(Bloomberg) -- The U.S. economy’s 4.1 percent rate of growth in the second quarter, the fastest since 2014, owed plenty to exports along with gains in consumer and business demand. Sustaining such a lofty pace will be tough as the boost from tax cuts fades, although some drags -- such as a drop in inventories -- may turn into a positive.

Economists’ forecasts show growth will come in around 3 percent this year. That indicates a somewhat more moderate pace than the April-June results, though better than the 2.3 percent average growth in the expansion that began in 2009. Here’s a deeper dive into how the components of gross domestic product performed last quarter, and how they may fare from here on.

Consumer Spending

Household consumption, which accounts for almost 70 percent of GDP, rebounded to a 4 percent rate of growth, higher than projected and following a 0.5 percent advance in the prior quarter. This part of the economy looks all set to keep growing, economists predict, thanks to a confluence of factors. In addition to lower taxes under the biggest overhaul since the Reagan era, consumers’ purchasing power is benefiting from steady hiring, an unemployment rate that’s near the lowest since 1969, improving finances and contained inflation.

At the same time, the Federal Reserve is raising borrowing costs and wage growth remains modest. Consumers’ paychecks grew at a slower pace last quarter, with after-tax incomes adjusted for inflation increasing at a 2.6 percent annual pace, softer than the 4.4 percent rate in the prior quarter. The saving rate fell to 6.8 percent from 7.2 percent. Car sales, which have held up surprisingly well this year, may also have trouble maintaining their recent pace.

Business Investment

The power of tax cuts was evident in this category as well, with nonresidential business investment climbing at a 7.3 percent pace after the first quarter’s 11.5 percent jump. That contributed almost 1 percentage point to second-quarter growth. Within this component, spending on structures advanced 13.3 percent, driven by oil and gas drilling, following a 13.9 percent gain in the prior period.

What's Next for U.S. GDP After Best Quarter of Growth Since 2014

Given that it was juiced by big incentives in the new tax package, it’s hard to say whether businesses will be inclined to keep up this torrid pace of investment in coming quarters. The energy sector may also provide less of a lift, as one indicator -- the rig count -- was already cooling toward the end of the second quarter, analysts said. In addition, residential investment was a drag on growth for the fourth time in five quarters amid signs that housing is poised for its broadest slowdown in years.

Net Exports

Perhaps the biggest temporary boost for growth came from a smaller trade deficit. Net exports contributed 1.06 percentage points, the most since 2013. The numbers reflected a 9.3 percent gain in shipments abroad, boosted partly by a surge in soybean shipments ahead of retaliatory tariffs as well as exports of petroleum and related products.

Few analysts are counting on this component to keep delivering amid headwinds including a strong dollar as well as tariffs that have been proposed or already implemented in a widening trade war. Besides, steady domestic demand from households and businesses means imports will pick up, potentially causing the trade deficit to widen.

Recent history is also a reminder that net exports aren’t often such a benevolent force for GDP growth as they were in the second quarter. This component was a drag in the prior two quarters and barely added to growth in several periods before that.

Inventories

One weak spot in the report was a decline inventories, which subtracted 1 percentage point from growth, the most since 2014. The Commerce Department cited soybean stocks as well as those of drugs and sundries and petroleum and related products. Given that demand is likely to keep growing, economists reckon businesses will rebuild stockpiles in the third quarter, so inventories may swing to being a contributor, from a drag. On average over longer stretches, this volatile and hard-to-predict category tends to be a wash in the GDP calculations.

Government Spending

Outlays by the government also helped in the pickup, increasing at a 2.1 percent rate and adding 0.37 percentage point to growth. Federal spending rose 3.5 percent, the second-fastest rate since 2014, boosted by defense expenditures, while state and local outlays advanced 1.4 percent. Economists expect some further contributions from this component, thanks to an increase in government spending signed into law earlier this year following the tax cuts.

What Our Economists Say

To be sure, there is evidence that tax reforms and cuts are helping to stimulate activity, but the performance of consumer spending in the second quarter is unlikely to carry through in full force into the second half of the year. As a result, the overall pace of growth will moderate. Bloomberg Economics is maintaining its forecast for 2.8 percent growth in the second half. Consumers are benefiting from tax cuts and a tighter labor market, but household income creation has not yet accelerated to a pace that can support 4 percent growth on a sustained basis.

-- Carl Riccadonna and Tim Mahedy, Bloomberg Economics

Read more for the full reaction note from Bloomberg Economics.

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net

To contact the editors responsible for this story: Scott Lanman at slanman@bloomberg.net, Vince Golle

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