Market Brief: US Economy Rebounds, But Underlying Indicators Point to Slowdown Ahead

The world’s biggest economy staged a snappish recovery in the second quarter as tariff front-running effects were unwound, but signs of moderating growth were clearly visible, suggesting that momentum is falling off.

Real gross domestic product climbed at a 3-percent seasonally-adjusted annual pace from April through June, reversing a -0.5-percent drop in the first three months of the year, and topping consensus estimates. Forecasters surveyed by Bloomberg had, on average, expected the economy to grow at a 2.6-percent rate in the second quarter. Net exports added 5 percentage points to the headline print after the sharpest decline on record in the first quarter.

But details under the hood were supportive of a cautious approach from the Federal Reserve. Consumer spending growth slowed to a post-pandemic low, business investment cooled, and real final sales to private domestic purchasers—a widely-watched measure of underlying demand—advanced 1.2 percent, down from 1.9 percent in the previous quarter, and the slowest since 2022. The central bank’s favoured inflation gauge—the core personal consumption expenditures price deflator—rose at an annual rate of 2.5 percent, faster than the expected 2.3 percent pace. The central bank wants to see inflation at 2 percent.

The dollar is climbing as traders push rate cut expectations slightly further into the future, lifting yields and widening interest differentials across the front end of the curve. Risk-sensitive currencies are pushing lower, and most North American equity markets are set to open a little below yesterday’s close. Just ahead of the report, President Donald Trump said he would impose 25 percent tariffs on India.

Other data releases have painted a somewhat-mixed picture of improving fundamentals in the US economy. According to numbers published yesterday, consumer confidence edged higher in July, as anxieties surrounding tariffs and the broader economic outlook appeared to moderate. The Conference Board’s index rose by two points to 97.2, slightly above the 96 consensus forecast. A sub-index measuring current conditions slipped to a three-month low, but the expectations gauge, which captures sentiment looking forward six months, climbed to 74.4—the highest level since February. In a separate report, US job openings declined in June—retracing some of the gains recorded over the previous two months—but layoffs remained low, suggesting that employers are not yet bracing for a downturn.

Investors are almost universally convinced that the Federal Reserve will hold interest rates steady for a fifth consecutive meeting this afternoon, yet considerable uncertainty lingers over the guidance policymakers will offer on the path forward. Some think Chair Powell will stick to his resolutely neutral, data-dependent posture, aiming to preserve the central bank’s flexibility until the underlying contours of the economy come into sharper focus. Others, however, believe the balance of risks is tilting toward labour market weakness, and are bracing for a more dovish tone—one in which Powell may cautiously signal openness to a rate cut as early as September. We lean toward the former view, particularly given the volume of data still due before the next decision—including two payrolls reports, multiple inflation prints, and a range of consumer spending indicators. Still, the case for easing has clearly grown more compelling, and it is conceivable that the consensus among members of the rate-setting committee is beginning to coalesce around the prospect of a near-term policy shift—after all, the last “dot plot” summary of economic projections showed two rate cuts occurring by year end, and there are only three meetings left after this one.

We would caution, however, against reading too much into the initial market reaction. Currency movements have reversed direction during several recent press conferences as Chair Powell has shed more light on the evolution of the central bank’s reaction function, and many market participants have been repeatedly wrong-footed by more extreme extrapolations of his comments. Expect turbulence, use market orders to capitalise on short-term volatility, but don’t base longer-range forecasts on perceived changes in the nuances of the Chair’s language.

We’re more wary. Although Mark Carney’s government could surprise us with a meaningful boost to economic growth and competitiveness, we think risks to the Canadian economy are still tilted to the downside. After artificially boosting activity, early-year tariff front-running effects are running out of steam, Canada’s exposure to private sector demand in the US remains a major vulnerability, and the all-important housing market is still mired in a long-term slump. If* the Bank publishes an updated set of forecasts this morning, the outlook could incorporate a relatively-speedy return to the inflation target along with a slowing in growth—a mix that would remain consistent with at least one more rate cut by early 2026.

For the Canadian dollar, risks are clearly two-sided: the consensus currently expects a grind higher over the remainder of the year, but there are reasons to suspect that the Canadian and global economies are currently enjoying a dead-cat bounce. We’re sticking to our 1.34 year-end target, but conviction is low, and data over the coming months could easily steer us closer to the 1.40 mark.

The euro is trading with a slightly weaker bias even after the economy expanded unexpectedly in the second quarter, powered by faster-than-anticipated growth in France and Spain. According to Eurostat, bloc-wide real gross domestic product grew 0.1 percent in the second quarter, but 0.3-percent and 0.7-percent prints in France and Spain obscured -0.1-percent contractions in Germany and Italy. Domestic demand across the euro area remained weak as firms—fearing the impact of tariffs—held off on investment and consumer sentiment stayed depressed. Inflation data later this week could change the dynamic, but with the bloom coming off early-year hopes for a fiscal policy- and rearmament-driven economic rebound, risks to the euro are skewing back toward the downside.

Apologies, two charts didn't make it into yesterday's missive. Here's the European Union's goods trade balance with the United States, illustrating how transfer pricing and tax avoidance strategies employed by the pharmaceutical industry have made a major contribution to trade imbalances:

And here is a measure of the degree to which incoming US data has begun to surprise economists to the upside:

Please note: Distribution of the daily Market Briefing will pause between August 4 and August 15 as I prepare for an extremely busy speaking agenda this autumn. I will, of course, send breaking news updates if any major market-moving developments occur.

*We're not confident they will: three months ago, the Bank opted to publish a set of scenarios in lieu of its traditional forecasts, and this may happen again.

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