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Showing posts with label Inflation. Show all posts
Showing posts with label Inflation. Show all posts

The US Economy Is Growing But the Iran War and Energy Prices Are Testing Its Limits

US economy GDP growth chart 2025 with AI investment and Iran war energy price impact


The American economy entered 2025 with a renewed sense of momentum. US GDP grew at an annualized rate of 2% in the first quarter of the year — a significant rebound from the 0.5% recorded in the prior quarter, according to fresh data released by the Commerce Department. While the figure fell modestly short of the 2.3% forecast projected by economists surveyed by FactSet, it painted a picture of an economy that arrived at a consequential geopolitical crossroads in notably strong condition.

The drivers behind that growth were wide-ranging: resilient consumer spending, a striking surge in business investment, stronger export figures, and the return of government outlays that had been effectively frozen during the longest federal shutdown on record in the preceding months. Together, these forces helped sustain an economy navigating a new set of headwinds — chief among them, the intensifying military conflict involving the United States, Israel, and Iran.

A Strong Foundation, Now Under Pressure

The timing of this GDP reading carries particular weight. The data reflects the state of the economy before the full economic impact of the Iran conflict began to materialize — a window during which larger-than-expected tax returns provided consumers with a temporary buffer against rising fuel costs. Most major US corporations also reported robust first-quarter earnings, and despite an initial wave of investor anxiety triggered by the conflict, equity markets eventually steadied, with major indexes recovering to sit at or near record highs.

Yet the picture beyond that first-quarter snapshot is growing more complicated. Now entering its ninth week, the Middle East conflict has become a source of sustained economic uncertainty. Global oil prices remain firmly above $100 per barrel, keeping US gasoline prices elevated and exerting mounting pressure on household budgets. The Federal Reserve, which had been expected to continue trimming interest rates, has been compelled to pause — unwilling to ease monetary policy while inflation risks remain elevated.

"As long as the economy continues to grow and companies are able to grow earnings, we can see higher stock prices even in the face of higher energy prices and inflation," said Chris Zaccarelli, chief investment officer at Northlight Asset Management. "However, the longer the war drags on, the more investors will grow nervous and we could see some pullbacks as fears ebb and flow."

The AI Investment Surge Defining Modern Economic Growth

Perhaps the most striking element of the first-quarter data was the extraordinary performance of business investment, which grew at a stunning annualized rate of 10.4% — more than four times the 2.4% pace recorded in the final quarter of last year, and the strongest rate of expansion since mid-2023. Economists widely attributed this surge to continued and accelerating investment in artificial intelligence infrastructure, equipment, and software across industries.

"This is still an AI-driven economy," said Olu Sonola, head of US economics at Fitch Ratings. "The longer the conflict with Iran drags on, the greater the risk that higher energy prices continue to push inflation up and ultimately dampen growth."

Not all economists, however, view the AI investment boom through an uncomplicated lens. Some caution that the sheer scale of technology-driven spending may be masking underlying weaknesses elsewhere in the economy — in sectors less insulated from energy costs, consumer pullbacks, and geopolitical volatility. Oliver Allen, senior US economist at Pantheon Macroeconomics, offered a measured assessment: "The AI build-out will continue to support investment. But investment elsewhere will remain anemic."

Consumer Spending: Growth With Caveats

Consumer spending — which accounts for approximately two-thirds of total US economic activity — grew at an annualized rate of 1.6% in the first quarter, a slight deceleration from the 1.9% pace of the prior quarter. The increase was driven entirely by spending on services, while outlays on goods edged lower over the period.

When adjusted for the 4.5% rise in prices recorded during the quarter, however, the real spending picture was less encouraging — declining at an adjusted rate of -2.5%. In other words, Americans were spending more in nominal terms, but actually purchasing less in real terms as inflation eroded their purchasing power. For many households, the boost from larger tax refunds earlier in the year is now at serious risk of being absorbed entirely by higher fuel costs.

"For the US consumer, any boost from tax refunds is likely to be wiped out by higher oil prices if they persist," Sonola added.

Core GDP and the Underlying Strength of Demand

One closely watched measure of fundamental economic health offered a more encouraging signal. Real final sales to private domestic purchasers — commonly referred to as "core GDP" and considered a reliable gauge of underlying demand — grew at an annualized rate of 2.5% in the first quarter, up from 1.8% in the quarter prior. This metric, which strips out more volatile components, suggests that the bedrock of domestic economic demand remained intact even as external pressures mounted.

Whether that underlying strength can be sustained through an extended period of elevated energy prices, persistent inflation, and geopolitical uncertainty remains the defining question of the months ahead. The US economy demonstrated real resilience entering 2025 — but the path forward will be shaped as much by events beyond its borders as by the forces driving growth from within.

Wall St Week Ahead Soft landing hopes for U.S. economy brighten outlook on stocks

Optimism is seeping back into the U.S. stock market, as some investors grow more convinced that the economy may avoid a severe downturn even as it copes with high inflation.

The benchmark S&P 500 (.SPX) has rebounded about 15% since mid-June, halving its year-to-date loss, and the tech-heavy Nasdaq Composite (.IXIC) is up 20% over that time. Many of the so-called meme stocks that had been pummeled in the first half of the year have come screaming back, while the Cboe Volatility Index (.VIX), known as Wall Street’s fear gauge, stands near a four-month low.

In the past week, bullish sentiment reached its highest level since March, according to a survey from the American Association of Individual Investors. Earlier this year, that gauge tumbled to its lowest in nearly 30 years,when stocks swooned on worries over how the Federal Reserve’s monetary tightening would hit the economy.

“We have experienced a fair amount of pain, but the perspective in how people are trading has turned violently towards a glass half full versus a glass half empty,” said Mark Hackett, Nationwide’s chief of investment research.

Data over the last two weeks bolstered hopes that the Fed can achieve a soft landing for the economy. While last week’s strong jobs report allayed fears of recession, inflation numbers this week showed the largest month-on-month deceleration of consumer price increases since 1973.

The shift in market mood was reflected in data released by BoFA Global Research on Friday: tech stocks saw their largest inflows in around two months over the past week, while Treasury Inflation-Protected Securities, or TIPS, which are used to hedge against inflation, notched their fifth straight week of outflows.

“If in fact a soft landing is possible, then you’d want to see the kind of data inputs that we have seen thus far," said Art Hogan, chief market strategist at B. Riley Wealth. "Strong jobs number and declining inflation would both be important inputs into that theory.”

Through Thursday, the S&P 500 was up 1.5% for the week, on track for its fourth straight week of gains.

Until recently, optimism was hard to come by. Equity positioning last month stood in the 12th percentile of its range since January 2010, a July 29 note by Deutsche Bank analysts said, and some market participants have attributed the big jump in stocks to investors rapidly unwinding their bearish bets.

With stock market gyrations dropping to multi-month lows, further support for equities could come from funds that track volatility and turn bullish when market swings subside.

Volatility targeting funds could soak up about $100 billion of equity exposure in the coming months if gyrations remain muted, said Anand Omprakash, head of derivatives quantitative strategy at Elevation Securities.

"Should their allocation increase, this would provide a tailwind for equity prices," Omprakash said.

Investors next week will be watching retail sales and housing data. Earnings reports are also due from a number of top retailers, including Walmart (WMT.N) and Home Depot (HD.N), that will give fresh insight into the health of the consumer.

Plenty of trepidation remains in markets, with many investors still bruised from the S&P 500’s 20.6% tumble in the first six months of the year.

Fed officials have pushed back on expectations that the central bank will end its rate hikes sooner than anticipated, and economists have warned that inflation could return in coming months. read more

Some investors have grown alarmed at how quickly risk appetite has rebounded. The Ark Innovation ETF (ARKK.P), a prominent casualty of this year’s bear market, has soared around 35% since mid-June, while shares of AMC Entertainment Holdings (AMC.N), one of the original "meme stocks", have doubled over that time.

“You look across assets right now, and you don’t see a lot of risks priced in anymore to markets," said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management.

Keith Lerner, co-chief investment officer at Truist Advisory Services, believes technical resistance and ballooning stock valuations are likely to make it difficult for the S&P 500 to advance far beyond the 4200-4300 level. The index was recently at 4249 on Friday afternoon.

Seasonality may also play a role. September - when the Fed holds its next monetary policy meeting - has been the worst month for stocks, with the S&P 500 losing an average 1.04% since 1928, Refinitiv data showed.

Wall Streeters taking vacations throughout August could also drain volume and stir volatility, said Hogan, of B. Riley Wealth.

“Lighter liquidity tends to exaggerate or exacerbate moves,” he said.