The structure of the U.S. economy is undergoing changes due to persistent inflation triggered by the Iran conflict: consumer spending is being squeezed by rising prices, while government expenditure and corporate investment, particularly in the field of artificial intelligence, are becoming the primary drivers of growth. This shift should be reflected in the first-quarter GDP data, even as the full economic impact of the U.S.-Iran conflict has yet to fully unfold.
At 8:30 PM Beijing time on Thursday, the U.S. will release its Q1 GDP data. The market expects the annualized growth rate of U.S. GDP in the first quarter to reach 2.3%, but the increase in consumer spending is projected to be a mere 1.4%.
The robust performance of U.S. Q1 GDP can largely be attributed to a significant rebound in federal government spending. At the end of 2025, the U.S. government experienced the longest shutdown in history, with disruptions in public services and over a million employees furloughed, costing the fourth-quarter GDP approximately one percentage point. If the conflict persists, forecasters believe that escalating defense spending will become another pillar supporting economic growth.
Joe Brusuelas, chief economist at RSM US, commented, “Ongoing investment in AI is indeed providing a strong tailwind for overall economic growth.” However, he also noted, “What could have been a strong start to a year of above-trend high growth now appears somewhat lackluster.”
AI Investment Boom and the Offset Effect of Trade Deficit
Over the past year, artificial intelligence has been a core driver of corporate spending, a trend expected to continue into 2026. Economists are closely monitoring expenditure data in areas such as information processing equipment and software to assess AI’s impact in the first quarter, while observing the extent to which construction spending is concentrated on data center development. However, the net contribution of such investments to GDP growth is significantly diminished due to heavy reliance on imported hardware components, which are offset in the final accounting by the trade deficit.
The surge in imports also reflects another factor: following the Supreme Court’s February decision to overturn several of Trump’s previous tariff policies, companies rushed to import goods in anticipation of new tariffs. Many economists expect net exports to weigh on Q1 GDP.
The Atlanta Fed's GDPNow forecasting model has provisionally estimated GDP growth at the beginning of the year at 1.2%, indicating that net exports may reduce economic growth by approximately 1.3 percentage points.
Multiple Supports from Government Spending
Amid the dual pressures of weak consumer spending and surging imports offsetting some corporate investments, government spending has become a key support for Q1 GDP data. JPMorgan’s Abiel Reinhart estimates that GDP will grow by 2.5% in the first three months of the year, but after excluding the boost from the end of the government shutdown, the growth rate is only about 1.5%.
The rise in military expenditures spurred by the Iran conflict may further boost government spending in subsequent data releases. Brusuelas noted, 'The current data is still too early to capture the strong boost that will soon appear in GDP government spending due to increased defense orders. We are likely to see a surge in goods orders in the second and third quarters, followed by a slight pullback.'
Bloomberg economist Eliza Winger pointed out in a report that the expected rebound in Q1 GDP largely reflects a mechanical recovery following the drag from last autumn's government shutdown, with underlying demand remaining rather weak. Fortunately, resilient business investment has partially offset the sluggishness in consumption.
The full picture of inflation is about to be revealed.
Data from the Bureau of Labor Statistics showed a record spike in gasoline prices in March, which continued to climb in April. Economists noted that even if the crisis could be resolved quickly and peacefully, the fact that energy production and refining facilities in the Middle East have already been damaged will keep energy prices high. Disruptions in the fertilizer market are propagating along global supply chains, and food prices are expected to rise accordingly this year.
The specific impact on inflation during the early stages of the conflict will be fully reflected in 'the Fed's preferred inflation gauge.' The market expects the personal consumption expenditures (PCE) price index, to be released alongside GDP data, to show a 3.5% year-over-year increase in March, the fastest pace since 2023; the month-over-month increase rose from 0.4% to 0.7%. For core metrics, core PCE is expected to rise 0.3% month-over-month, slowing from the previous 0.4%; year-over-year growth is expected to reach 3.2%, up from 3% the previous month.
Notably, the CPI data for March, released earlier this month, had already sounded an alarm. The March figures showed an overall CPI increase of 3.3% year-over-year, driven primarily by energy prices, while core CPI grew by 2.6% year-over-year.
Investors will attempt to dissect the PCE report to be released tonight to clarify the state of inflation drivers unrelated to the conflict. If the core PCE year-over-year increase for March reaches the expected 3.2%, it may indicate that stubborn inflation, which existed even before the outbreak of the Middle East conflict, persists.
EY-Parthenon chief economist Gregory Daco pointed out that consumer spending was likely temporarily boosted last month due to high tax refunds legislated last year, while severe cold weather across much of the country at the beginning of the year dampened consumption willingness. 'You can count on high tax refunds to provide a bit of a buffer, but much of it will be swallowed up by soaring gas prices at the pump.'
Goldman Sachs analysts have raised their forecasts for this data, partly due to the oil price surge triggered by the Iran conflict. In a report, the firm stated that it now expects core PCE to rise 2.6% year-over-year by December this year, up from the previous forecast of 2.5%; overall PCE is projected to reach 3.4% by year-end, significantly revised upward from the prior estimate of 3.1%. Excluding the estimated impact of high energy prices and U.S. tariffs, core PCE is expected to rise 2.3% year-over-year in March, easing to 2.1% by year-end.
Goldman Sachs analysts, including Elsie Peng, pointed out that oil flow through the Strait of Hormuz will recover at a 'slower' pace and is not expected to fully normalize until the end of June, with Gulf region capacity suffering 'moderate but lasting damage.' They predicted that the global benchmark Brent crude futures would average $100 in April and May, retreating to $90 in the fourth quarter, with upside risks for oil prices.
Goldman Sachs has developed a specialized model to estimate the transmission of commodity cost increases to consumer prices, encompassing the impact of rising domestic energy, food, and other non-energy export goods from the Gulf region. The model currently indicates that these factors will push up core PCE by approximately 0.35 percentage points and overall PCE by about 1.25 percentage points by 2026.
Analysts at the institution also noted that many Asian and European countries reliant on exports from the Gulf region face greater energy cost shocks and upward risks compared to the United States. Since the outbreak of conflict in late February, wholesale prices for refined oil products and natural gas in these regions have surged significantly more than in the U.S. However, they cautioned that this still "points to another potential driver of rising consumer prices in the U.S.—the spillover effects of overseas energy cost shocks through import prices."
Editor/KOKO