US Q2 GDP report rules out the small chance of a July interest rate cut

Q2 GDP figures come in on the top-side

A stronger set of Q2 GDP figures than expected from the US today, with output growing at an annualized rate of 2.8%, significantly above expectations of a 2.0% reading and double the 1.4% print seen for Q1. But the strength being seen today is probably unsustainable going forward, given that the key drivers behind today's number, items such as stronger government spending and private fixed investment, are things that look set to weaken going forward. But despite this, the report should put to bed the suggestions that have been made recently that the Fed should be cutting interest rates at next week’s FOMC meeting.

Domestic consumption strong, but expected to weaken

Aside from government spending and capex, the main driver behind Q2’s stronger performance was a bounce back in consumption, which jumped from Q1’s reading of 1.5% to 2.3% in Q2. But this does not suggest that domestic consumption is likely to start trending higher. The slower pace of growth seen in real after-tax incomes this year compared to last year, when incomes rose by 4.2%, almost double the long-run average, necessarily points to a slowdown in spending over the year as a whole, while signs that unemployment is slowing creeping higher, in turn exerting downwards pressure on wages growth, will further curtail spending as consumers opt to boost precautionary savings against the growing risk of being made redundant. Accordingly, it is hard to see the consumption boost reported today as being anything other than temporary.

Business sector similarly unlikely to provide much support going forward

And there is unlikely to be any significant boost to growth emanating from the business sector either. Despite today’s better capex numbers, the series is volatile, while the downbeat surveys of capex intentions now regularly being seen suggest the direction of travel for business investment going forward will be downwards. And this is no surprise given the penal rates of interest businesses, particularly small businesses, are facing when making investment decisions, and where real borrowing costs are rising. On top of this, an uncertain economic outlook, most notably stemming from the US Presidential election, is also likely to see business investment slow; the threats being made by Trump to impose a further round of hefty import tariffs if he wins the White House do nothing to boost business confidence.

PCE deflator shows pricing pressures still trending downwards

Potentially disappointing on the surface is the core Q2 PCE deflator, which rose by 2.9%, beating forecasts for a 2.7% print, and suggesting some upside risk to tomorrow’s PCE numbers. However, the pace of growth fell from the 3.1% figure recorded for Q1, to leave the underlying pace of growth in core PCE still trending downwards. As such, there is nothing here that should be disconcerting for the Fed.

But big picture remains a slowing US economy

But despite the better overall growth numbers today, the picture still being painted is one of the US economy slowing down, as consumer spending and business activity both cool in the face of the monetary tightening delivered by the Fed; the key message is more one that it is not slowing as much as had been anticipated. And for the Fed, this is good news, as with inflationary pressures once more on a weaker trajectory, it suggests the ‘soft landing’ it is trying to achieve is close to being delivered. But right now, it makes the case for cutting rates next week difficult to make. And if tomorrow’s PCE numbers do indeed come in above expectations, it makes justifying a July rate cut optically difficult. Accordingly, our base case scenario remains for the Fed to deliver a first 25bps cut in September.