US GDP (Q1 2026 – first estimate)

Real GDP growth was revised 0.4 percentage points (ppt) lower to a modest 1.6% in Q1 2026, following a lackluster 0.5% increase in Q4 2025. The US economy is facing intensifying supply-side headwinds from Middle East-related disruptions, elevated tariffs and tighter immigration constraints, only partially offset by continued strength in AI-related investment. The net result is a more stagflationary backdrop characterized by firmer inflation pressures and weakening real activity.

Layered supply shocks from tariffs, immigration restraints and persistent geoeconomic tensions in the Middle East continue to generate inflationary pressures that sustain nominal growth while masking considerably weaker inflation-adjusted activity.

Still, private sector demand showed relatively firm momentum at the start of the year, while corporate profit margins remained near record highs. Yet the expansion continues to rest on three narrow “A-pillars” of growth: affluent consumers, AI-driven investment and asset price appreciation. Together, these pillars are masking an increasingly uneven economic foundation in which nominal resilience obscures softer real growth across broad segments of the consumer base, housing activity and trade-sensitive industries.

In the details

• Government spending added 0.7ppt to real GDP growth, with roughly 0.5ppt reflecting a rebound in federal outlays following the prior quarter’s government shutdown disruptions.
  
  
• Real final sales to private domestic purchasers — GDP excluding trade, inventories and government spending — rose 2.7% annualized and 2.1% year over year (y/y), but growth is increasingly reliant on a drawdown in savings, greater use of credit and household wealth, along with concentrated AI-related investment activity.
  
  
• Real consumer spending growth advanced a modest 1.4%, driven primarily by higher-income households’ continued demand for services even as durable and nondurable goods spending grew marginally.
  
  
• Business investment rebounded a healthy 10.1% despite a 5.4% plunge in structures investment. Equipment spending surged 17.2%, driven by information processing equipment, while intellectual property products increased 11.6%, further underscoring the concentration of business spending in AI-related activity.
  
  
• Housing activity remained depressed, with residential investment falling for the fifth consecutive quarter, down 6.3% annualized in Q1.
  
  
• Net international trade subtracted 1.3ppt from growth as imports (+21.1%) rebounded faster than exports (+13.1%).
  
  
• Corporate profits (with inventory valuation and capital consumption adjustments) rose $40.4 billion in the first quarter, with domestic financial profits falling $3 billion, domestic nonfinancial profits surging $105 billion and rest-of-the-world profits falling $61 billion. Profit margins eased half a tick to 13.8% of GDP — still near their all-time high.
  
  
• Inflation accelerated in Q1 with headline personal consumption expenditures (PCE) inflation firming 0.3ppt to 3.8% y/y and core PCE inflation firming 0.2ppt to 3.3%. Meanwhile, April data suggest headline inflation rose further to 3.8% y/y early in Q2 while core inflation has picked up to 3.3% y/y.

While direct military confrontation in the Middle East has eased following the ceasefire, disruptions to shipping flows through the Strait of Hormuz remain significant, and broader regional stabilization has yet to materialize, leaving downside risks elevated. Although we continue to anticipate a gradual normalization in global energy and commodity production and trade flows in coming months, we maintain our below-consensus call for 1.8% US real GDP growth this year.

We have raised our inflation forecast, with headline PCE now expected to peak around 4.0% y/y before easing to 3.7% by Q4, while core PCE is projected to end the year at 3.0% y/y.

Incoming Fed Chair Kevin Warsh faces a challenging backdrop as resilient labor market conditions alongside rising inflation risks raise the bar for rate cuts and reinforce the case for a prolonged pause. Despite Warsh’s (recent) dovish leanings, Fed communication suggests the June Federal Open Market Committee (FOMC) statement could adopt a more explicitly two-sided formulation acknowledging that additional tightening could be appropriate if inflation remains above target. Already, some Fed governors and regional Fed presidents are openly discussing the possibility that the next policy move could be a rate hike.

Our expectation remains that the Fed will remain on hold through the remainder of the year, and we do not exclude the possibility of more regular two-sided dissents at upcoming meetings, including from the Fed Chair.

The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.