US economic growth slows to 2.8% as inflation, job cuts mount

The US economy is cooling faster than expected, with growth forecasts slashed and inflation at a three-year high, threatening the stock market's spring rally.

The US economy is cooling faster than expected, with second-quarter growth estimates slashed to 2.8% from 4.3% and inflation hitting a three-year high of 4.2%, threatening the stock market's spring rally.

"The sugar rush from bigger-than-usual tax refunds will wear off soon," said Samuel Tombs, chief US economist at Pantheon Macroeconomics.

Retail sales excluding volatile items surged 9.2% in the three months through May, but the gain was fueled by roughly $39 billion in tax refunds from last year's One Big Beautiful Bill Act, Morgan Stanley estimates. Gasoline sales alone accounted for a third of May's headline retail increase, while food services spending fell 0.1%. The labor market is also deteriorating: employers cut 97,000 jobs in May, the largest monthly total since 2020, with advances in artificial intelligence cited as the most common reason, according to Challenger Gray.

The weakening backdrop tests the bull market thesis of "steady but unspectacular" growth. The Atlanta Fed's GDPNow tracking tool points to a 2.8% second-quarter pace, down sharply from its 4.3% estimate in early May. Wall Street consensus sits at just 2.1%, below the 1.6% recorded in the first quarter and well off last year's 3.8% pace.

Tax Refund Sugar Rush Masks Consumer Weakness

The May retail sales figures revealed a K-shaped recovery that is widening. High-income households, boosted by significant wealth gains from rising equity markets, are spending vigorously, said James Knightley, chief international economist at ING. Middle and lower-income households, under financial strain from high prices and weak income growth, are treading water.

The divergence is visible in the data. While overall retail sales appeared strong, the underlying composition tells a different story. Gas sales — driven by WTI crude surging to $109 a barrel, more than 40% higher than last year — comprised a disproportionate share of the headline gain. May tax refunds totaled roughly $4 billion, well shy of the $13 billion Americans paid in higher gasoline prices during the same month, Tombs noted.

AI-Driven Job Cuts Reshape Labor Market

The 97,000 job cuts in May marked the largest monthly layoff total since 2020, with artificial intelligence advances cited as the primary driver, according to Challenger Gray's broad report. The technology sector alone eliminated more than 142,000 positions in the first five months of 2026, putting the industry on pace for nearly 370,000 by year-end.

"On top of the headline AI story, we're seeing a sharp rise in cuts tied to acquisitions and mergers and a jump in bankruptcy-related losses, which tells me companies are restructuring aggressively as they reposition for an AI-driven economy," the Challenger Gray report noted.

The impact is falling disproportionately on younger workers. Employment among software developers aged 22 to 25 has fallen nearly 20% since 2024, according to Stanford HAI's 2026 AI Index, while developers aged 30 and older at the same companies saw headcount grow. Software development job postings have fallen 53% since the release of ChatGPT in late 2022.

Wage growth cooled to 3.4% in May, while hours worked rose 0.3% from a year earlier — a combination that signals workers are putting in more time for less real income. "That erosion in real wage growth is meaningful, and suggests that consumer spending is increasingly being supported by savings or equity market gains, both of which tend to be less durable than income-driven demand," said Brent Schute, chief investment officer at Northwestern Mutual.

What's at Stake for Markets

The combination of slowing growth and elevated inflation creates a challenging environment for the Federal Reserve. With inflation at 4.2%, the highest in three years, the central bank has limited room to cut rates even as the economy decelerates. The Fed is expected to hold rates steady at its next meeting, with OIS markets pricing a low probability of a cut before the fourth quarter.

For equity markets, the risk is that the consumer-driven growth story that has supported the spring rally is running out of fuel. House prices are stagnant, suggesting the wealth effect is boosting consumption by only a little over one percentage point, "no more than usual," Tombs said. With tax refunds fading and wage growth cooling, the second half of the year will test whether the bull market can withstand a weakening economic backdrop.

This article is for informational purposes only and does not constitute investment advice.