The United States economy demonstrated resilience in the first quarter of 2026, registering a gross domestic product (GDP) annualized rate of 2%, according to data released Thursday by the Commerce Department. This figure marks a significant increase from the fourth quarter’s sluggish 0.5% growth, although it falls slightly short of the 2.3% projection made by economists in a FactSet poll. The economic expansion occurred as the United States and Israel launched military operations against Iran, a conflict that has already disrupted global markets and driven up energy costs.
Drivers of Growth: Services and AI Investment
The primary engine behind this first-quarter growth was resilient consumer spending on services. Spending in this sector grew at an annualized rate of 1.6%, down slightly from the previous quarter’s 1.9%. However, when adjusted for a 4.5% increase in prices during the same period, real consumer spending actually declined by an adjusted rate of -2.5%. Despite this drop in purchasing power, businesses provided a massive boost to the economy with investment spending surging at a stunning annualized rate of 10.4%, up from just 2.4% in the fourth quarter.
Economists attribute much of this business surge to continued investments in artificial intelligence (AI). Oliver Allen, senior US economist at Pantheon Macroeconomics, noted that while AI build-outs support investment, spending elsewhere remains anemic. Olu Sonola from Fitch Ratings echoed this sentiment, describing the current landscape as "still an AI-driven economy." Real final sales to private domestic purchasers, a key gauge of underlying demand known as core GDP, strengthened sharply to 2.5%, up from 1.8% in the prior quarter.
Impact of Middle East Conflict on Inflation and Rates
The ongoing war with Iran, now entering its ninth week, presents significant challenges for future economic stability. Global oil prices remain firmly above $100 a gallon, keeping US gas prices elevated and prompting the Federal Reserve to delay any further interest rate cuts. Chris Zaccarelli, chief investment officer at Northlight Asset Management, explained that while higher stock prices can persist alongside inflation if corporate earnings grow, prolonged conflict increases investor nervousness.
"As long as the economy continues to grow and companies are able to grow earnings, we can see higher stock prices even in the face of higher energy prices and inflation," Zaccarelli stated. However, he warned that "the longer the war drags on, the more investors will grow nervous." The conflict has also impacted government outlays, which returned after a record-long shutdown in the previous quarter, alongside a boost from bigger tax returns that helped offset initial price spikes at the pump.
Market Reaction and Future Outlook
Despite the geopolitical turmoil, major stock market indexes have rebounded to or near record highs. Most companies reported robust first-quarter earnings, suggesting that corporate America remains adaptable in a volatile environment. However, economists broadly agree that the longer the Middle East conflict persists, the more damage it will inflict on US economic growth through rising inflation.
For American consumers, the outlook is mixed. While tax refunds provided some initial relief, Olu Sonola cautioned that any boost from these refunds could be wiped out by persistent higher oil prices. As the war continues to jacked up prices across various sectors, the US economy faces a delicate balancing act between maintaining its AI-driven investment momentum and mitigating the inflationary pressures of an ongoing international conflict.
