Don’t be fooled by slowing GDP. The economy is strong.

Gross domestic product slowed to 1.5% in the second quarter in the United States, but a large part of that slowdown can be attributed to a significant increase in the trade deficit that subtracted 1% from overall growth.

In the end, the top-line GDP figure, which decelerated from 2.1% in the first quarter, offers a misleading indication of just how strong the American economy is.

The rise in the trade deficit was caused by imports needed for the buildout of artificial intelligence infrastructure that is transforming the American economy.

If anything, those imports paint a portrait of strength, robust consumer demand and inflation that remains above the Fed’s 2% target.

Beneath the top-line figure, growth looks much firmer and inflationary as the GDP price index advanced by 6.2% and the core personal consumption expenditures index, the Federal Reserve’s preferred inflation gauge, rose by 3.4% on a quarter-over-quarter basis.

The rise in the GDP price index was the sharpest since the 2022 inflation shock.

The primary drivers of growth were robust household spending and non-residential investment, which is linked to the artificial intelligence buildout.

Fed policymakers will ignore that top-line number and focus on the robust consumer spending and recent jump in energy prices that have pushed inflation well above the central bank’s 2% target.

This dynamic will inject an additional source of contention inside the raucous family fight at the Fed that has spilled out into public view.

The data

Household consumption increased by 3.2%, real final sales by 2.5%, and final sales to private domestic purchasers excluding inventories and trade by 3.9%. Gross domestic purchases increased by 2.5%.

Given the rise in imports linked to the AI buildout, we think that alternative metrics provide a much better look at underlying growth trends and risks to the inflation outlook than the top-line GDP.

While we think that over the medium to long term the AI buildout will bolster productivity and cool growth in inflation, in the near term it will be a source of rising prices as demand for goods and services increases.

Outlays on goods increased by 5.2%, durables by 6.8%, non-durables by 4.4% and services by 2.2%.

Gross private investment increased by 3% in dollar terms and non-residential investment soared by 8.4%.

Fixed investment increased by 7%, while spending on productivity-enhancing equipment increased by 15.2% and intellectual property by 8.8%. Residential investment increased by 1.5%.

Exports increased by 4.5% and imports by 11.5% while government consumption declined by 0.8%. Inventory accumulation declined by $50.8 billion in the second quarter of the year.