Second Quarter 2026 Economic Report

News from the second quarter is a mixed bag, as usual. Many concerning headlines catch our attention, but there’s still a healthy thread of news that keeps me optimistic. Let’s take a look…

What’s in the news:

The war in Iran has gone on for five months and instead of winding down it is pulling in more Middle East nations. I don’t see anything that makes me believe it will end soon. I hope I am wrong. Oil prices remain elevated, but at a level below earlier estimates. The Strait of Hormuz is essentially closed.

Core inflation as measured by the Core PCE¹ was reported at 3.7% annualized, significantly above the Fed’s 2% target. It is becoming more apparent that getting the rate to 2% is going to take longer than previously expected. Chairman Warsh’s statement that “The economy is showing impressive resilience” combined with the second quarter inflation rate translates into a higher probability of rate increases than rate cuts particularly with a stable 4.2% unemployment rate. The Fed has indicated it will no longer provide forward guidance on rates. I am going to miss that forward guidance!

Tariffs are back on again under a different law and apparently have a better chance of surviving legal scrutiny than those implemented previously. This may make inflation harder to beat.

Sluggish GDP figure may be understated:

GDP growth in the second quarter slowed to 1.5%, below expectations of 2.7%. However, an argument can be made that the economy is actually stronger than this number indicates. As you have read, massive amounts of money are being spent building data centers and a large part of that is spent on imported goods. GDP is a net number after deducting the value of imported goods, and early analysis indicates importing goods had an unusually large impact on GDP. In addition, U.S. companies reduced inventories, possibly as a tariff mitigation strategy. This also reduced GDP. Government spending contracted by 0.8% but this will come back in future periods. For a different look at underlying economic strength look at “final sales to private domestic purchasers.” This excludes imports, inventory adjustments, and government spending. That number grew at a 3.9% annualized rate according to Reuters, up from 1.7% in the first quarter. So, private sector demand showed strong growth despite the sluggish GDP report. 

Consumer Spending is still strong among high income households:

Real consumer spending grew at a 3.2% annualized rate compared to 0.5% in the first quarter. However, our current K-shaped economy² may be giving us false confidence. Moody’s Analytics reports that households in the top 10% of income currently make up approximately 50% of total consumer spending. Another source places spending by the top 20% of earners at 57% of total consumer spending. If the stock market has a correction, high-income households will feel the negative sentiment the most, causing a slowdown in spending and potentially putting our economy at risk. 

Lower- and middle-income households are feeling the pressure of inflation and particularly higher energy costs. The average price of gasoline in the second quarter was $4.22 per gallon. Further evidence of this weakening is a drop in the savings rate to 2.7%, lowest since June 2022. No doubt the second quarter consumption was higher than expected, but the question of sustainability comes into play considering the lower savings rate.  We have talked in the past about consumer sentiment surveyed by the University of Michigan and The Conference Board. Their July surveys continue to show negative consumer outlooks for the future.

Corporate earnings and profits remain strong:

Corporate earnings are a bright spot. They are coming in very strong. FactSet projects S&P 500 earnings in the second quarter will grow by 25% over last year. That would be the strongest quarterly growth since 2021. Seven of the eleven S&P sectors are showing double digit growth in earnings and revenue. Profit margins have remained strong as companies have succeeded in passing higher costs through to consumers and forward guidance for most companies has been maintained or raised.

So what to make of all this…

I am more optimistic about our economy than I was last quarter. Although we are still facing high energy costs, oil prices did not stay at the dangerously high $120/barrel we saw at the onset of the war. While inflation is certainly high and taking a toll on households, consumer spending grew, albeit at the cost of lower savings. As discussed above, businesses are healthy, and AI spending is contributing heavily to economic health. Employment remains stable. These conditions are not typically precursors to recessions. However, we will be monitoring the economy and any changes in conditions. Please reach out with questions or comments– we would love to discuss these points with you! 

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¹ Core PCE: Core Personal Consumption Expenditures– a key inflation measure that tracks the prices people living in the U.S. pay for goods and services, published monthly by the Bureau of Economic Analysis and used by the Federal reserve to gauge inflation when setting interest rates

² A K-shaped economy describes a divided financial landscape where different groups or sectors move in opposite directions—one part thrives and rises while the other struggles and falls, resembling the arms of the letter “K”