US GDP grew 2.1% in Q1 as economy defied slowdown fears

The US economy expanded at more than double the pace of the prior quarter, complicating the Federal Reserve's path on interest rates.

The US economy grew at a 2.1% annualized rate in the first quarter, the Commerce Department said Thursday, more than quadruple the prior quarter's pace and well above the 1.6% that economists had forecast in a Bloomberg survey.

"The GDP revision confirms the economy entered 2026 with more momentum than the soft data suggested," said James Knightley, chief international economist at ING. "But the 4.4% core PCE print leaves the Fed with no room to cut."

The final estimate was an upgrade from the 1.6% advance reading and marked a sharp rebound from the 0.5% expansion in the final three months of 2025, when a 43-day federal government shutdown weighed on activity. Business investment surged, reflecting what economists described as an AI-driven capex boom, while consumer spending fell sharply from both the fourth quarter and the prior estimate. Core PCE inflation — the Fed's preferred gauge — was finalized at 4.4%, unchanged from the previous estimate and matching consensus.

The combination of above-trend growth and sticky inflation reinforces the "higher for longer" narrative that has dominated rate markets since the start of the year. Traders have pushed back expectations for the first rate cut to the fourth quarter, with the September meeting now seen as a coin flip. The first reading on second-quarter GDP is due July 30.

Growth Rebound Masks Consumer Weakness

The headline expansion was driven largely by a surge in nonresidential fixed investment, which economists attributed to corporate spending on artificial intelligence infrastructure. But the composition of growth was uneven: personal consumption expenditures — the main engine of the US economy — slowed markedly from the prior quarter, raising questions about the durability of the expansion.

The labor market has provided a counterweight. Employers added an average 188,000 jobs a month from March through May, a sharp acceleration from the subdued pace of 2025, when uncertainty over trade and immigration policies weighed on hiring. Initial jobless claims came in at 215,000 for the week ended June 20, below the 225,000 consensus estimate, the Labor Department reported Thursday. Continuing claims rose to 1.82 million, suggesting that while layoffs remain low, the pace of rehiring has slowed.

Sticky Inflation Complicates Fed Calculus

The 4.4% core PCE reading — more than double the Fed's 2% target — leaves policymakers in a bind. The last time core PCE ran this hot was in early 2023, when the Fed was still in tightening mode. That cycle ended with the fed funds rate at 5.25% to 5.50%, where it has remained since July 2023.

"The GDP data is a double-edged sword for the Fed," said Knightley. "Strong growth reduces recession risk, but persistent inflation means they cannot ease. The market is caught between those two forces."

Treasury yields rose after the release, with the two-year note — the most sensitive to rate expectations — climbing 4 basis points to 4.12%. The S&P 500 opened lower as rate-sensitive sectors including real estate and utilities led declines. The dollar index edged up 0.2%.

Looking ahead, the path of inflation over the next two months will determine whether the Fed can cut in 2026 at all. The next consumer price index report is due July 15, followed by the Fed's July 28-29 policy meeting. If core PCE remains above 4% through the summer, the first cut may not come until 2027.

This article is for informational purposes only and does not constitute investment advice.