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The US economy is just fine. But the Fed wants to make it even finer

Gwynn Guilford
By Gwynn Guilford

Reporter

Global growth seems to be weakening fast, and the world’s central bankers are preparing their monetary arsenal for a rate cut.

But on the mid-North American front—which includes, of course, the Federal Reserve, the bank with the planet’s biggest bazooka—all is still quiet. Well, mostly.

In the second quarter, the US grew at a brisk 2.1%, according to the advance estimate produced by the US Bureau of Economic Analysis. The expansion was buoyed by big spending by both consumers and the government, offsetting an unexpected slump in business investment.

That’s slower than the 3.1% pace of growth in the first quarter. But, on average, analysts expected a much sharper drop. Despite better-than-anticipated GDP growth, however, the consensus holds that the Fed will probably cut rates. “In short, this slowdown just about justifies a 25bp [basis points] cut by the Fed next week, but the chances of a bigger 50bp reduction just receded further,” writes Paul Ashworth, economist at Capital Economics.  One hundred basis points is equivalent to one percent.

Since they drive nearly seven-tenths of the US economy, American consumers are critically important. True to form, they saved the day. “The 4.3% consumer spending splurge was the largest since Q4 2017,” noted Gregory Daco and Jake McRobie, economists at Oxford Economics. That compares with the anemic 1.1% pace of growth in Q1.

Business investment is a smaller part of the economy—which is good, since it was unusually lousy last quarter. Weak spending on residential construction continues to drag on growth. But the collapse of spending on structures and equipment is more disconcerting. Still, thanks to US consumers and a bump in federal government spending, it wasn’t enough to dent overall growth much.

How the US economy did last quarter is a big deal because it’s likely to be a major factor influencing the Federal Reserve’s monetary policy decision next Wednesday.

So you might expect the big questions here to be: Is what we’re looking at a marked weakening in the US economy? Is it broad-based enough to signal that, unless the Fed comes to the rescue, the decade-long expansion that will surely end? And even counting the investment slump, the answer is probably ‘uh, not really.’

There’s something else to consider, though. Based mostly on remarks by FOMC members in recent weeks, investors have already been betting on a rate cut. The second quarter GDP performance would need to be so amazing that it warrants upending those expectations—and triggering market mayhem in the process.

In addition, Fed members have been paying a lot of attention to the sluggishness of inflation these days—which, according to normal economic logic, should have picked up given the low unemployment rates (Quartz’s Allison Schrager recently broke down why). In today’s report, core consumer prices rose a feeble 1.8% versus the previous year. That should help calm any fears that a rate cut will stoke a flare up of inflation. There’s far less consensus, however, on the number of rate cuts that lie in store throughout the rest of 2019.

That will depend a good deal on how the US economy holds up—and on that score, today’s announcement left us with one heartening sign: Revisions to existing data reveal that Americans have been socking away their earnings much more than anyone realized.

The revision pushed the personal saving rate up to 8.5% in the first quarter—way above than the previous estimate of 6.7%—says Capital Economics’ Ashworth. “Admittedly, the saving rate then fell back to 8.1% in the second quarter,” he adds, “but that still leaves it well above normal and suggests households have plenty of scope to keep spending freely.”

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