The U.S. economy expanded at a 2% annual pace in the first quarter of 2026, recovering from last fall's 43-day federal government shutdown, but the Iran conflict's blockade of critical energy routes threatens to undermine consumer spending and fuel inflation pressures that could stall the recovery.
The Commerce Department reported Thursday that gross domestic product, the nation's output of goods and services, rebounded from a 0.5% expansion in the last three months of 2025. The improvement came as federal government spending and investment grew at a 9.3% annual rate in the first quarter, adding more than half a percentage point to growth after subtracting 1.16 percentage points in the fourth quarter of 2025.
Consumer Spending Slows as Energy Costs Rise
Consumer spending, which accounts for 70% of U.S. economic activity, slowed to 1.6% in the first quarter from 1.9% at the end of 2025. Spending on goods, including food and clothing, fell slightly, and spending on services slowed. The deceleration reflects mounting pressures on household budgets as Iran has blocked the Strait of Hormuz, through which a fifth of the world's oil and liquefied natural gas passes, driving energy prices higher, fueling inflation and hurting consumers.
Heather Long, chief economist at the Navy Federal Credit Union, wrote, "This is a split-screen economy," adding, "Companies and investors involved in AI are on fire. Meanwhile, middle and moderate income households are struggling with high gas prices ... Consumption is slowing as people are struggling to manage all their bills and growing more concerned about the future."
Business Investment Surges on AI Spending
Business investment, likely driven by spending in artificial intelligence, rose at an 8.7% pace, demonstrating the private sector's capacity to drive growth through innovation and capital deployment. Excluding housing, nonresidential investment surged 10.4%, the biggest jump in nearly three years. The robust business investment contrasts sharply with residential investment, which fell at an 8% annual pace, the fifth straight quarterly drop and the biggest since the end of 2022.
A category within the GDP data that measures the economy's underlying strength grew at a 2.5% pace, up from 1.8% in the fourth quarter of 2025. That category includes consumer spending and private investment, but excludes volatile items like exports, inventories and government spending.
Uncertainty Clouds Economic Forecasting
Imports rose at an annual rate of 21.4% from January through March, cutting more than 2.6 percentage points from first-quarter growth. The first quarter included about a month of the clash in Iran. The Federal Reserve, announcing Wednesday that it was keeping its benchmark interest rate unchanged, cited "a high level of uncertainty" arising from the conflict.
Carl Weinberg, chief economist at High Frequency Economics, wrote Monday that he did not even bother to forecast first-quarter GDP growth. "The truth is that we do not have any defensible basis for trying to project how these indicators will print," Weinberg wrote. "Trump's war with Iran has led to a total blockade of the Strait of Hormuz. We do not know how to model the impact of that event, as we have never seen anything quite like it."
Thursday's report was the first of three Commerce Department estimates.
Why This Matters:
The divergence between strong business investment and weakening consumer spending reveals an economy increasingly dependent on private sector innovation while households face mounting fiscal pressures from energy-driven inflation. The Iran conflict's disruption of global energy markets threatens to accelerate inflation precisely when the Federal Reserve needs stability to maintain its current monetary policy stance. The surge in AI-related business investment demonstrates the economy's capacity for growth through market-driven innovation, but the collapse in residential investment signals persistent challenges in housing affordability that government interventions have failed to resolve. With imports surging and subtracting significantly from growth, the data underscores concerns about trade imbalances and energy security that require decisive policy responses to protect American consumers and businesses from external shocks beyond their control.