The first quarter Gross Domestic Product (GDP) report confirmed what the weekly data had been hinting at: the economy grew at a respectable 2% pace, underpinned by an artificial intelligence investment surge that added more than a full percentage point to growth. The punch line is that artificial intelligence (AI)-related imports subtracted just as much from the other side of the ledger, leaving the net contribution at zero and inflation as the only lasting residue of the boom.

Executive Summary

• First quarter gross domestic product grew at a 2.0% annualized rate, in line with consensus. Real final sales to private domestic purchasers, a better gauge of underlying activity, rose 2.5%, with information technology (IT) equipment and software adding more than 1 percentage point to growth, more than double the pace of last year.
• Consumer spending rose 1.6% annualized, held back by weather early in the quarter. The Personal Consumption Expenditures (PCE) price index rose 0.7% in March and 3.5% year-over-year, while the personal saving rate fell to 3.6%, its lowest since October 2022.
• On a net basis, AI-related categories added nothing to first quarter GDP, as the surge in imports fully offset the investment gains. Imports of AI-related equipment have nearly doubled over the past year, while non-AI imports have fallen nearly 28%.
• The Federal Reserve held rates steady at the April Federal Open Market Committee (FOMC) meeting with a hawkish tilt: the statement upgraded inflation to “elevated” from “somewhat elevated,” and three members dissented over language implying the next move would be a cut. We now expect the next rate cut in December, not June.
• The Institute for Supply Management (ISM) manufacturing index held steady in April, with broadening new orders and low customer inventories, but price pressures from the AI buildout and energy passthrough continue to build.
• Consumer confidence rose for a third straight month to 92.8. Initial jobless claims plunged to 189,000, well below expectations, with no sign of labor market deterioration from the war.
• Housing starts jumped 10.8% to 1.502 million in March, but building permits fell sharply, pointing to a reversal in April.

The GDP Report: Solid on Paper, Fragile Underneath
First quarter GDP grew at a 2.0% annualized rate, matching consensus, but the core of the economy held up better than the headline suggests. Real final sales to private domestic purchasers, which strips out inventories and trade, rose a stronger 2.5%, with IT equipment and software investment alone adding more than 1 percentage point, more than double the pace of its contribution from 2025. Consumer spending rose 1.6% annualized, held back by weather at the start of the quarter; the March personal spending data showed a solid rebound in real terms at quarter-end.

That strength owed much to the tax refund windfall, which through March and most of April outpaced the increased gasoline burden by a ratio of two to one. With refund season winding down and gas prices still climbing, the hit to consumer spending will become more evident starting in May.

The PCE price index rose 0.7% in March and 3.5% year-over-year, and with incomes not keeping pace, the personal saving rate dropped to 3.6%, its weakest since October 2022. The other GDP components were noisy: federal spending rebounded sharply from the record-long government shutdown, while a surge in AI-driven imports dragged net exports by more than a full percentage point.

• Key Takeaway: The core economy is growing at or above trend, but the composition is fragile. Strip away the government rebound and the tax refund boost, and you find a consumer running on fumes and a saving rate that cannot fall much further.

The AI Paradox: Adding Everything, Netting Nothing
The most striking detail in the GDP report had nothing to do with the headline number. AI-related categories, taken together, added nothing to first quarter growth on a net basis. Investment in IT equipment and software surged, contributing more than a full percentage point, but AI-related imports surged by an equal amount, as most chips and electrical equipment are sourced abroad. The scale of the divergence is remarkable: imports of AI-related equipment have nearly doubled over the past year, while imports of everything else, excluding pharmaceuticals and gold, have fallen nearly 28% since “liberation day.”

For now, the AI boom appears inflationary rather than disinflationary, as rampant demand for memory chips and semiconductors has created a global shortage that is pushing up consumer electronics prices. Unless AI begins feeding through to productivity gains quickly enough to bring down unit labor costs, the Federal Reserve may need to keep policy settings tighter for longer to contain the goods inflation that the buildout is generating.

• Key Takeaway: The AI buildout is the economy’s most powerful investment engine and its most persistent source of inflationary pressure. Until productivity gains catch up to spending gains, the Federal Reserve will treat the boom as a reason to wait, not a reason to cut.

The Fed Goes Hawkish: December, Not June
The Federal Reserve left interest rates unchanged at the April FOMC meeting, as expected, but the details of the accompanying statement tilted in a hawkish direction. The statement upgraded inflation from “somewhat elevated” to “elevated,” and noted the increase was only “in part” due to energy prices, a signal that officials see broader forces at work. Three members dissented over language implying the next rate move would be a cut —further evidence of the deep split on the committee around the policy outlook. It is now more likely that the next rate cut will be in December rather than June, reflecting a stickier inflation outlook driven by the AI buildout, the passthrough of energy costs to core prices and lingering tariff effects.

This was almost certainly Jerome Powell’s last meeting as Federal Reserve chair, with the Senate Banking Committee advancing Kevin Warsh’s nomination; Powell has vowed to stay on the board as a governor until the Department of Justice investigation is “fully over.” It is likely that rampant AI-related demand for electronics and related equipment will keep core PCE inflation close to 3% over most of this year. The Employment Cost Index (ECI) offered some comfort, with year-over-year growth in compensation costs holding steady at 3.4%, the slowest pace since the second quarter of 2021 and a rate that remains consistent with the Federal Reserve’s 2% inflation target when paired with strong productivity growth.

• Key Takeaway: Three hawkish dissenters and a rewritten inflation assessment signal that the bar for cutting has risen. December, rather than June, is not just a timing change; it reflects a Federal Reserve that seems to increasingly view AI-driven goods inflation as structural rather than transitory.

The Consumer: Still Spending, but the Cushion Is Gone
The Conference Board’s measure of consumer confidence rose for the third consecutive month in April, reaching 92.8, buoyed by the ceasefire and the rebound in equity markets. Consumers’ year-ahead inflation expectations edged down to 6.1% from 6.2% in March, though they remain well above the 5.5% registered before the war.

The labor market differential, measuring the gap between those saying jobs are plentiful and those saying they are hard to find, improved to 7.5 points from 5.8. Yet beneath the improving headline, consumers reported fewer plans to purchase big-ticket items or spend on services, a signal that the oil price shock is beginning to alter spending behavior. The labor market remains the economy’s shock absorber. Initial jobless claims plunged 26,000 to 189,000 in the week ended April 25, well below expectations, and continued claims declined 23,000 to 1.785 million, with the four-week moving average at its lowest since May 2024. The March consumer spending rebound was genuine, but the tax refund tailwind that powered it is fading; with gas prices still rising, the drag on consumer spending will become visible starting in May.

• Key Takeaway: Consumer confidence and the labor market both improved this week, but the underlying story has not changed. The tax refund buffer is gone, gas prices keep climbing and a personal saving rate at 3.6% leaves almost no cushion for what comes next.

Housing and Manufacturing: Mixed Signals, Persistent Constraints
Housing starts jumped 10.8% in March to a seasonally adjusted annual rate (SAAR) of 1.502 million, far above consensus, though building permits fell 10.8% to 1.372 million, signaling that the March pace will not repeat. Builders still need to work through an overhang of completed unsold homes that stood at 2009 levels earlier this year; mortgage rates have retraced about half the increase that followed the onset of the war, which should support some sales but will not unlock a sustained recovery in starts. Home price growth continued to decelerate, with the S&P CoreLogic Case-Shiller national index posting its slowest annual gain since June 2023 at 0.7% year-over-year, though base effects are set to turn more favorable starting with the March data.

On the manufacturing side, the ISM manufacturing index held steady in April, with broadening new orders and low customer inventories providing a constructive backdrop for future production. Factory employment, however, fell further into contraction, reinforcing signs of a nascent productivity upswing, while slower supplier deliveries pointed to supply chain bottlenecks forming around the closure of the Strait of Hormuz.

• Key Takeaway: Housing is caught between a weather-driven bounce in starts and a structural overhang in unsold inventory. Manufacturing is holding steady for now, but the combination of falling employment and rising prices tells a productivity story that the Federal Reserve will watch closely.

Final Thoughts
The first quarter confirmed what the weekly data had been suggesting: the economy is growing at trend, the AI buildout is both supporting and complicating the picture and the Federal Reserve has no reason to move until the data force its hand. It is now more likely to see a single rate cut in December, later than consensus but more dovish than current market pricing, which implies little change in rates over the coming years. Consumer spending is on track for growth of nearly 2% this year, but the composition makes it unusually fragile, with an outsized reliance on high-income households who benefit from tax cuts and wealth effects; a sustained stock market correction would hit spending harder than normal.

The Middle East situation is the primary source of uncertainty, though hard data signals remain benign. The deeper question is whether the AI boom that is keeping the Federal Reserve on hold will eventually deliver the productivity gains that make its own inflation manageable. That is a question measured in years, not quarters. In the meantime, the economy faces a summer stretch where the tax refund tailwind has faded, gas prices remain elevated and the labor market, while stable, is beginning to feel the leading edge of AI adoption through rising layoffs in the information sector. The consumer, running on fumes and a saving rate of 3.6%, will be the first to tell us if something has broken. So far, the answer is no. But the margin of safety is thinner than it has been in years.

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