Wealth Insights

Economy Commentary

The Economy

Economy Proving To Be Resilient, But Downside Risks Linger

May 2026

The first estimate from the Bureau of Economic Analysis (BEA) pegs Q1 real GDP growth at an annual rate of 2.0 percent, shy of what our forecast anticipated but it helps to recall that in any given quarter BEA’s initial estimate of GDP is based on highly incomplete source data and, as such, prone to sizable revision. As the data now stand, real private domestic demand (combined business and household spending) is shown to have grown at an annual rate of 2.5 percent in Q1. We consistently point to real private domestic demand as the more reliable gauge of the underlying health of the U.S. economy, as what tend to be sharp swings in net exports and business inventories often sway the headline GDP growth print. While it is not surprising that growth in real private domestic demand outpaced real GDP growth, what does stand out is the extent to which business fixed investment drove growth in private domestic demand in Q1.

Real business fixed investment grew at an annual rate of 10.4 percent in Q1, a pace made even more impressive in light of real business spending on structures contracting at a 6.7 percent rate. Real business outlays on equipment and machinery grew at a 17.2 percent rate in Q1 while real outlays on intellectual property products, the bulk of which consists of computer software and R&D outlays, grew at a 13.0 percent rate, with the former adding 0.88 percentage points to top-line real GDP growth and the latter adding 0.70 percentage points. Investment related to AI was a powerful support for the growth in business investment seen in the GDP data, but we’ve routinely noted that growth in business investment in equipment and machinery has become more broadly based over recent months, in part thanks to the more favorable tax treatment resulting from last summer’s changes to the tax code.

Growth in real consumer spending slowed in Q1, with annualized growth of 1.6 percent more than accounted for by spending on services, as real spending on goods contracted despite growth in nominal spending (i.e., measured at current prices) on goods having accelerated sharply. Nominal goods spending rose at an annual rate of 5.2 percent in Q1 after having risen at a 2.3 percent rate in Q4 2025. That real goods spending contracted while growth in nominal goods spending accelerated so sharply reflects the pace at which goods prices rose during Q1. While this in part reflects the steep increases in energy prices during March, it also reflects further tariff pass-through pushing prices for core (non-food, non-energy) consumer goods higher, with the core PCE Price Deflator rising at an annual rate of 4.4 percent after having risen at a 4.6 percent rate in Q4 2025. Moreover, the PCE Deflator’s measure of core goods prices rose at an annual rate of 4.9 percent in Q1.

The combination of faster goods price inflation and sharply higher energy prices poses downside risk to growth in consumer spending going forward. One offset in Q1 was a sharp acceleration in disposable (after-tax) personal income growth, fueled by meaningfully larger income tax refunds than seen in 2025, another byproduct of last summer’s changes to the tax code. We and most others expected this tax refund windfall to be a strong support for growth in consumer spending over 1H 2026, but the strength of that support has been eroded by steeper than expected price increases. One way to think about it is that higher prices mean consumers have to spend more just to keep pace, leaving less room for growth in real spending. The longer energy prices remain elevated, the less support for growth in real spending to be had from larger income tax refunds, particularly in light of accelerating core goods price inflation.

It seems likely that, should they remain elevated, higher energy prices will ultimately spill over into core inflation in the form of higher costs of producing and shipping goods. That the Strait of Hormuz is not only a shipping channel for energy but also for industrial and consumer goods opens additional avenues through which the conflict in the Middle East can intensify upward pressure on goods prices. To that point, the New York Fed’s index measuring supply chain stresses shows significantly more stress on global supply chains in April, with the index jumping to a level last seen in mid-2022 when pandemic related supply chain disruptions were fueling inflation price pressures. Note that prices of core consumer goods had turned higher, reflecting the effects of higher tariffs, well before supply chains came under renewed pressures.

To the extent they persist, these supply chain pressures could be reflected in further acceleration in core goods price inflation, and it is possible that we’re already seeing the early stages of such a transition. For instance, the prices paid index, a gauge of changes in input prices, in the ISM Manufacturing Index jumped to 78.3 percent in March before rising further still to 84.6 percent in April, the highest reading since April 2022, and has risen by over twenty-five percentage points over the past three months. In ISM’s April survey 70.3 percent of firms reported paying higher input prices, up from 59.4 percent in March. Keep in mind, though, that the prices paid index had been signaling persistent and broadly based upward pressures on input prices long before the start of the conflict in the Middle East, meaning that the conflict has intensified what were already well-entrenched price pressures. The ISM’s survey of the broad services sector tells a similar story, i.e., firmly entrenched price pressures kicking into a higher gear as a result of the conflict in the Middle East.

Thus far, however, supply chain disruptions and higher prices for energy and other inputs have not derailed the nascent rebound in the manufacturing sector. The ISM Manufacturing Index held at 52.7 percent in April, the fourth straight month in which the headline index was above the 50.0 percent break between contraction and expansion, though as we’ve noted the turnabout in the ISM’s index lagged other indicators which had already been signaling better conditions in the manufacturing sector. The conflict in the Middle East, however, poses new hurdles for the manufacturing sector, but the ISM’s April survey shows no signs of deterioration in order books, while at the same time firms again reported larger backlogs of unfilled orders. While this would suggest support for employment and output in the factory sector in the months ahead, the longer the conflict in the Middle East persists the greater the danger that supply chain disruptions and higher input prices bring an abrupt end to the rebound in manufacturing.

That job growth exceeded expectations in both March and April has many wondering if the narrative around the labor market has changed. We think not and can point to factors such as atypically harsh winter weather, seasonal adjustment issues, and Easter having fallen so early in April this year, which have impacted the past few monthly employment reports. Such twists and turns in the data, however, are standard fare, which is why it’s more useful to look at longer-term patterns. For instance, over the past six months total nonfarm payrolls have risen by an average of 55,000 jobs per month, and while that may not seem all that impressive, it is above what we consider to be sufficient to keep the unemployment rate steady given what we expect will remain anemic labor force growth.

To us, this is simply the new labor market normal; there is considerably less turnover in the labor market than has historically been the case, and we continue to point to labor supply constraints as a drag on job growth. We’ll repeat a point we’ve been making over the past few months, which is that with such a low trend rate of job growth the typical variability in the estimates of the change in nonfarm payrolls will likely yield negative headline prints more often than has historically been the case. This puts us at odds with those for whom the narrative of the labor market changes with each headline print on the monthly employment reports.

In light of the series of shocks that have hit the economy over recent years, it is striking that real GDP growth is nonetheless right back in line with the trend rate, just over two percent, that has prevailed for many years now. At the same time, however, that nominal GDP growth remains far above what had been the pre-pandemic norm reflects how intense and persistent inflation pressures have been, with inflation likely to accelerate further in the near term. At present, solid growth in business investment, a labor market that while not firing on all cylinders has at least stabilized, and consumers still willing and able to spend are supporting real GDP growth. The risk, however, is that elevated energy prices and global supply chain disruptions lead firms to pull in the reins on capital spending and pare job counts, while unrelenting price pressures cause consumers to pull back. That combination could easily sink the economy, and while not our base case, we’re certainly mindful of the downside risks.

Sources: Bureau of Economic Analysis; Bureau of Labor Statistics; U.S. Census Bureau; Institute for Supply Management; Federal Reserve Bank of New York

As of May 14, 2026