Unlike a month ago the final set of revisions to Q1 data were substantial. New monthly data (for May and June) have been mixed, without any obvious up versus down bias. At the end, our short-term outlook is stronger than a month ago.
NIPA Data
The 3rd estimate of real output for 2026Q1 put growth of real output at 2.1% – a significant improvement from the 2nd estimate’s 1.6%.
This came even though estimated growth of consumer spending fell from a barely adequate 1.4% to a weak 0.5%, with the entire decrease coming from purchases of services. The faster overall growth came from a large decrease in growth of imports which resulted in a significantly lower estimate of the net export deficit – a positive for GDP.
These revisions modify our interpretation of the quarter: Overall growth was adequate but distorted by a large post-shutdown increase in government spending, which we view as transitory. Underneath there was strong growth business investment (revised higher). However, this growth rested completely on spending related to AI. And the weakened growth in consumer spending is troubling.
Recent Monthly Data
New data over the past month are sort of like the current weather here in Bloomington. The temperature is lower than last week, but the humidity remains oppressive. It feels like it could rain, which is a pain, but would be good for my wife’s flower garden, which has been glorious so far this year. In short, a mix of positives and negatives, with nothing dramatic in either direction.
Data from the labor market illustrate this ambivalence. The household survey had the unemployment rate for June down a tick to 4.2%. Using the rate calculated to two decimal points this was the third decrease in the past four months, which sounds like a “good news” trend. Except that it has been accompanied by a steady drop in the labor force (also three of four months). The drop in unemployment is due to unemployed workers who stop looking for work rather than those who are finding new jobs.
Demand for labor from the establishment survey had an employment increase of “just” 57 thousand. That is barely above one-third the 164 thousand average over the previous three months. On the other hand, it is basically in line with the 50 thousand average for the two-year period preceding the recent surge. June private sector employment rose 49 thousand, nearly all accounted for by healthcare. Despite the World Cup, leisure and hospitality shed 61 thousand jobs.
In other labor market data, payroll services firm ADP estimated that the private sector added 98 thousand workers in June. And job openings for May came in at 7.59 million. This is their highest level since May 2024 and is up more than a million since December.
Another area of the economy that we consider crucial is household income and spending, where we got new data for May. Both real income and real consumption had adequate increases for the month, showing growth at an annualized rate of just over 3%. The saving rate came in at 3.0%, just matching an upward revised April number. This is still lousy, but better than at original 2.6% for April. Consumer sentiment jumped in June but remains very low. This coincided with some progress toward oil flow through Hormuz and reduced gas prices. But there has been back-sliding on both during the past week.
Overall, a picture with clouds, maybe even enough for a weather watch message. But nothing that we think warrants a severe weather – take shelter immediately – warning.
Baseline Forecast
As shown in the chart, our revised forecast is more optimistic for the next year than a month ago. The change amounts to GDP growth over the four quarter period that starts with the now completed Q2 that averages about 0.4% above our June outlook.
The improvement results almost completely from a more optimistic expectation for business investment related to AI. Over the four quarters we now have growth in equipment and intellectual property investment growing at 8.7%. This is almost 2% higher than last month, but well below the 14.7% rate registered in Q1.
Discussion
We think our revised forecast is tilted toward optimism.
First, the AI phenomenon is encased in multiple layers of uncertainty. There is uncertainty about the viability of the technology itself, about the business model of the firms involved, about their financing, about their demands for power and water, about the impact on labor demand among users, and on, and on.
Second, our forecast has the household sector continuing to muddle through. This is obviously far from a given.
Third, the situations in both Ukraine and especially in the Middle East could easily go south.
Fourth, the mid-term election is getting closer.
And, of course, each of the above affects all the others.