Darkening Outlook from Tariffs, Deportations Obscured by Q2 Data
By Reuters | 28 Aug, 2025

A surge in AI Investments and a shrinking job market produce data that paint a rosier picture than emerging economic realities as businesses struggle to cope with tariff disruptions.

The U.S. economy grew faster than initially thought in the second quarter, in part driven by business investment in intellectual property such as artificial intelligence, but tariffs on imports continued to cloud the outlook.

The upgrade to gross domestic product reported by the Commerce Department on Thursday also reflected upward revisions to consumer spending as well as business investment in equipment. That resulted in a measure of underlying domestic demand also being revised higher. With the Federal Reserve focused on a softening labor market, economists expected the U.S. central bank to resume cutting interest rates next month.  

"I doubt this moves the needle for the Fed, but at the margin, these revisions work against the case for urgency to cut rates," said Stephen Stanley, chief U.S. economist at Santander U.S. Capital Markets. 

GDP increased at a 3.3% annualized rate last quarter, the Commerce Department's Bureau of Economic Analysis (BEA) said in its second estimate. The economy was initially reported to have grown at a 3.0% pace in the second quarter. Economists polled by Reuters had expected GDP growth would be raised to a 3.1% rate. 

The economy contracted at a 0.5% pace in the January-March quarter, which was the first GDP decline in three years.

The manner in which President Donald Trump's administration has implemented the tariffs, including escalations and 90-day pauses, has muddied the waters, making it challenging to parse economic data. A front-loading of imports as businesses rushed to beat the duties pulled down GDP in the first quarter before snapping back as the flow of foreign merchandise ebbed.

Neither first- nor second-quarter GDP readings are a true reflection of the economy's health because of the wild swings in imports. To get a better read of the economy, economists are focusing on the final sales to private domestic purchasers measure, which excludes trade, inventories and government spending. 

This measure, also viewed by policymakers as a barometer of underlying economic growth, increased at an upwardly revised 1.9% pace last quarter, matching the first quarter's pace.

Domestic demand was initially estimated to have grown at a 1.2% rate. The revision reflected upgrades to consumer spending, the economy's main engine, which is now estimated to have increased at a 1.6% rate. That was up from the previously reported 1.4% pace.

Business spending on intellectual property products grew at a 12.8% rate, double the initially estimated 6.4% pace.

"Investment related to AI is helping mask some of the weakness elsewhere in the economy, but the good news is that there is little sign that this support is set to fade anytime soon," said Ryan Sweet, chief economist at Oxford Economics. 

Growth in business investment in equipment was upgraded to a 7.4% pace from the 4.8% rate estimated last month.  

Still, economists expect a lackluster second half, which would limit economic growth to about 1.5% for the full year because of tariffs. That reading would be down from 2.8% in 2024.

CORPORATE PROFITS REBOUND

The BEA also reported that profits from current production with inventory valuation and capital consumption adjustments rebounded $65.5 billion last quarter. Profits decreased $90.6 billion in the January-March period. 

But further increases are likely to be hampered by Trump's protectionist trade policy, which has raised the nation's average import duty to its highest level in a century, inflicting pain on companies ranging from retailers to manufacturers.

Caterpillar this month warned tariffs could cost the economic bellwether up to $1.5 billion this year.

In July, General Motors' second-quarter earnings took a $1.1 billion hit from the duties and the automaker anticipated more pain in the third quarter. Clothing retailer Abercrombie & Fitch on Wednesday warned that higher tariffs on countries such as Vietnam, Indonesia, Cambodia and India would increase costs by $90 million this year. 

Fed Chair Jerome Powell last week signaled a possible interest rate cut at the central bank's September 16-17 policy meeting, in a nod to rising labor market risks, but also added that inflation remained a threat. 

The Fed has kept its benchmark overnight interest rate in the 4.25%-4.50% range since December. 

News on the labor market remained mixed, with a report from the Labor Department showing initial claims for state unemployment benefits decreased 5,000 to a seasonally adjusted 229,000 for the week ended August 23. The labor market is stuck in a no-hire, no-fire mode due to tariffs. 

The number of people receiving benefits after an initial week of aid, a proxy for hiring, fell 7,000 to a seasonally adjusted 1.954 million during the week ending August 16, the claims report showed. The so-called continuing claims data covered the week during which the government surveyed households for August's unemployment rate. 

Continuing claims rose slightly between the July and August survey weeks, leaving some economists expecting the unemployment rate will rise to 4.3% in August from 4.2% in July. 

A survey from the Conference Board on Tuesday showed the share of consumers viewing jobs as "hard to get" jumped to a 4-1/2-year high in August. But a shrinking labor market pool because of the White House's immigration crackdown is softening the impact of lackluster hiring on the unemployment rate. 

Economists said reduced labor supply suggests the economy needs to create less than 90,000 jobs per month to keep up with growth in the working population. 

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama, Paul Simao and Andrea Ricci)