The GDP report's case for rate cuts

Data: U.S. Department of Commerce; Chart: Axios VisualsHere's some irony for you: In the details of Wednesday's GDP report, you can find a solid case for Federal Reserve interest rate cuts. However, it's the opposite of what President Trump blasted out Wednesday morning.Why it matters: Despite a robust headline number, underlying domestic demand looked strikingly soft in Q2 — and the softness was driven in significant part by interest rate-sensitive sectors bearing the brunt of Fed policy.Meanwhile, inflation was well-contained.Driving the news: Overall GDP rose at a 3% annual rate in the April-through-June quarter, the Commerce Department said, bouncing back after contracting in Q1.The major driver of the swings was an import surge in Q1, as companies sought to get ahead of tariffs. Imports fell back to normal levels in Q2, which, in the arithmetic of GDP, created a surge.Trump noted the GDP gain was "WAY BETTER THAN EXPECTED!" on Truth Social and said that Fed chair Jerome Powell "MUST NOW LOWER THE RATE."Yes, but: Underlying private-sector demand grew at the slowest pace in more than two years — and contraction in both the residential and commercial construction sectors was a reason why.It suggests that the Fed's policy of keeping rates elevated is unnecessarily dragging down overall growth.By the numbers: Real final sales to private domestic purchasers — which excludes the effects of trade and inventory swings, as well as government spending —rose at only a 1.2% rate in Q2, the weakest since the end of 2022.That figure, a measure of underlying private-sector demand, rose at a 1.9% rate in Q1 and was up 3% for the full year 2024.It was held down in Q2 in significant part by contractions in residential investment (which fell at a 4.6% annual rate) and investment in business structures (which fell at a 10.3% annual rate). Both those sectors contracted in Q1 as well.Homebuilders and commercial construction executives have complained about high interest rates as a headwind.Of note: The Personal Consumption Expenditures Price Index, the Fed's preferred inflation measure, rose at only a 2.1% annual rate in Q2, which is awfully close to the Fed's 2% goal.That said, core PCE inflation, which better captures underlying inflation trends, clocked somewhat higher at 2.5%.Between the lines: An economy with below-trend underlying demand, where rate-sensitive sectors are ailing, paired with near-target inflation, is the textbook story of an economy in which interest rates should no longer be in restrictive territory.The case for delaying rate cuts hinges on projections of what will happen to inflation trends in the future as the impact of tariffs filters through to consumer prices.What they're saying: "The policy takeaway here is that the economy is growing well below the 1.8% long term trend which will lead to a policy change at the Federal Reserve once they get a sense of where inflation is on the back of tariff induced inflation," wrote RSM chief economist Joe Brusuelas in a note.The bottom line: The strongest case for an interest rate cut is not that GDP is booming, but that the underlying trend is weak — and elevated rates are a reason.

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