U.S. economy wavers between consumer frenzy and war headwinds: strong domestic demand can't prevent GDP slowdown to 1.5%, oil price decline helps PCE unexpectedly fall

According to Zhisheng Finance APP, despite a strong rebound in consumer spending and a continued boom in business investments surrounding artificial intelligence (AI), U.S. economic growth in the second quarter of this year still slowed significantly and fell short of market expectations, dragged down by a widening trade deficit and inventory declines.

Preliminary estimates released Thursday by the U.S. Department of Commerce's Bureau of Economic Analysis showed that, after adjusting for inflation, gross domestic product (GDP) grew at an annualized rate of 1.5% quarter-on-quarter in the second quarter. This growth rate not only slowed from the 2.1% in the first quarter but was also well below the 2.1% economists widely forecasted. However, after the official release of leading economic indicators, some economists had already revised their forecasts down to as low as 1.5%, so the final data matched the updated expectations.

Strong Domestic Demand: Dual Engines of Consumption and Investment

The overall weakness in GDP data largely conceals the resilience of domestic demand in the U.S. Accounting for more than two-thirds of U.S. economic activity, consumer spending was particularly outstanding in the second quarter, with its annualized quarterly growth rate surging from 0.5% in Q1 to 3.2% in Q2.

The robust recovery in consumption was supported by multiple one-off factors. Thanks to the "One Big Beautiful Bill" promoted by former President Trump, American households received more generous tax refunds this year than in previous years, which partly offset the erosive impact of higher gasoline prices—caused by Middle East conflicts—on purchasing power.

In addition, a phase-out of gasoline costs at the end of Q2, increased promotions by retailers, as well as nonprofit expenditures related to the recently concluded World Cup and midterm elections, all stimulated consumption to varying degrees. In June, consumer spending adjusted for inflation increased by 0.4% month-on-month, tying the largest single-month increase since July 2025.

The growth in household spending was mainly due to durable goods such as furniture and motor vehicles. In terms of services, spending on discretionary categories like entertainment and accommodation and dining increased significantly.

Meanwhile, business investment remains the backbone of economic growth. Amid fierce competition in the AI sector, tech giants ignored investor concerns over high valuations and continued heavy investment. Major technology companies such as Meta (META.US) and Microsoft (MSFT.US) continued massive investments in building data centers in Q2 and accelerated AI infrastructure deployment. In addition, robust demand for industrial and transportation equipment also contributed significantly. After Wednesday’s Fed meeting, Federal Reserve Chairman Kevin Walsh described the economy’s resilience as “impressive” and noted that the most “noteworthy” feature was the strong momentum of business investment.

Because trade fluctuations often distort overall GDP data, economists closely monitor a more precise domestic demand indicator that strips out trade, inventory swings, and government spending—domestic private final sales. This metric rose 3.9% in the second quarter, more than double the pace of the first quarter, marking the strongest performance since early 2023 and further confirming that the U.S. economic foundation remains unshaken.

War Headwinds: Net Exports and Inventories as the "Achilles Heel"

From the breakdown of GDP data, changes in foreign trade and inventories were the main drags on the economy. In Q2, net exports shaved a full percentage point off GDP. This was due in part to companies rushing to import before a new round of tariffs took effect and reflected the surge in demand for capital goods imports.

Inventory changes further lowered GDP by about 0.67 percentage points, indicating that during the prolonged six-month war with Iran, many firms actively chose to deplete inventories.

Non-residential fixed investment grew at an annualized rate of 8.4%. Within this, investment in industrial equipment registered its biggest increase since 2011, and investment in transportation equipment reached its fastest pace in two years. Investment in information processing equipment and software continued growing but at a slower speed.

Although domestic demand remains robust, the shadow of war is gradually eroding economic prospects. With hostilities rekindling in the Middle East, average gasoline prices across the U.S. have once again climbed above $4 a gallon. As wage growth struggles to keep pace with inflation, American households are being forced to tap their savings or lower their savings rates to maintain current consumption levels. Economists have warned that in the face of increasing economic uncertainty, this consumption pattern may be unsustainable, predicting that households may soon shift toward precautionary savings, which will inevitably weaken domestic demand—the economy's currently strongest pillar—and bring downside risks to the U.S. economy in the second half of the year.

Inflation and the Fed: Internal Divisions Emerge

On the inflation front, data released on the same day showed that the Fed's preferred inflation gauge—the Personal Consumption Expenditures (PCE) price index—fell 0.1% month-on-month in June, its first decline since 2020. This price decrease was mainly due to lower international oil prices after a temporary ceasefire agreement between the U.S. and Iran. Year-on-year, inflation eased from a three-year high of 4.1% the previous month to 3.7%. The core inflation indicator, which excludes energy prices, rose just 0.1% in June—below market expectations. For the twelve months to June, core PCE rose 3.3% year-on-year, down from 3.4% the prior month.

However, price pressures from geopolitical conflicts have not been eliminated. June’s easing was mainly due to the decline in oil prices after the U.S. and Iran agreed to peace talks. But major disagreements remain, and oil prices are still relatively high. Inflation will likely remain above 3% through the end of the year, putting continued pressure on the Federal Reserve.

On Wednesday, the Federal Reserve decided to keep its benchmark overnight interest rate unchanged in the 3.50%-3.75% range, but unusually, three dissenting policymakers “preferred” a 25 basis-point hike at this meeting. In its statement, the Fed noted that although the Middle East conflict poses significant uncertainty, economic activity is still expanding solidly.

The Fed regards the PCE price index—especially core PCE—as the most accurate gauge of U.S. inflation trends. This measure shows inflation has now run above the central bank’s 2% target for six consecutive years. Market analysts expect the Fed could resume rate hikes as early as September to decisively curb inflation, casting a shadow over the economic outlook for the second half of the year.