Economists were in disarray on Thursday after new data showed evidence of persistent inflation and slowing growth in the United States. Real gross domestic product (GDP) grew just 1.6% in the first quarter from a year earlier, the Bureau of Economic Analysis said. reported Thursday. That was well below economists’ consensus forecast of 2.5% growth and a significant decline from the 3.4% growth seen in the fourth quarter of last year.
Meanwhile, the Federal Reserve’s favorite inflation gauge, the core personal consumer expenditures (PCE) price index, which excludes more volatile food and energy prices, rose from 2% in the fourth quarter of 2023 to 3.7% in the first three months of this year. . , easily beating the 2.1% inflation forecast by the Survey of Professional Forecasters in February.
“It was the worst report in both worlds: growth was slower than expected, inflation was higher than expected,” said David Donabedian, CIBC Private Wealth’s U.S. chief investment officer. Luck by email.
Donabedian said the “biggest setback” was the jump in core inflation, especially in the services sector, where consumer price growth exceeds 5% a year. For Fed Chairman Jerome Powell and his fellow central bankers, who had been hoping to see inflation fall so they could cut interest rates and stimulate the economy, the new data means even tougher times lie ahead. “We are not far away from all the rate cuts meeting investor expectations,” Donabedian said. “This is forcing Chairman Powell to take a hawkish tone at the FOMC meeting next week.”
Citi economists led by Veronica Clark echoed that view Thursday, arguing the Fed’s favorite inflation gauge is likely to rise to 2.8% when March data is released Friday, forcing central bank officials to take a more aggressive stance. As a result, Clarke and her team now expect the first interest rate cut to come in July rather than June. “However, we still believe markets are wrong to cut prices entirely this year,” she wrote.
With fiscal stimulus support waning and commodity spending softening, economic growth concerns will eventually weigh on the Fed as it decides whether to cut interest rates or keep them elevated. “We continue to think Fed cuts will occur this summer before inflation slows sustainably,” Clark said.
However, investors were clearly focused on evidence of persistent inflation in Thursday’s first-quarter GDP report and appeared less enthusiastic about the chances of a sharp rate cut coming this summer. The Dow Jones Industrial Average fell 1.5% by midday Thursday as investors digested the first-quarter GDP report, the S&P 500 fell 1.1% and the tech-heavy Nasdaq Composite fell 1.5%.
After many leading Wall Street forecasters and economists recently adopted a new forecast for the U.S. economy – a “no-landing” scenario with more robust economic growth and slightly higher inflation – EY Chief Economist Gregory Daco said that the GDP report for the first the quarter destroyed this theory too. . “This report pours cold water on the misleading narrative of accelerating economic growth,” he said. Luck by email.
Daco said he believes economic growth will continue to slow in the second quarter due to “persistent inflation,” tight credit conditions and weaker labor demand. “And we emphasize that if inflation proves more resilient than expected, the risk of economic downside from lower real income growth, the Fed’s ‘higher and longer’ stance and tightening financial conditions could become noticeable,” he said. .
David Russell, head of global market strategy at TradeStation, even argued that the US economy could be facing a nightmare economic scenario that has happened since the 1970s.
“Stagflation is a growing risk following a fall in GDP and an unexpected rise in the price index,” he said. Luck by email. “If inflation doesn’t improve with such weak growth, you have to wonder whether the downward trend in prices will continue.” This theory was supported by JPMorgan Chase CEO Jamie Dimon, who told The Wall Street Journal This week, stagflation is a risk the Fed can’t ignore.
Caution on weak GDP data
While the first-quarter GDP report was certainly cause for concern, there were some cautions regarding the weak growth statistics. First, private domestic demand, a measure of the ratio of actual final sales to domestic purchases, actually rose 3.1% in the first quarter. “The 3.1% rise in real private domestic investment is encouraging as it tends to be a strong leading indicator of future GDP growth in the short term,” William Bair analyst Richard de Chazal explained on Thursday.
Spending on health care, financial services, insurance and other services also continued to rise in the first few months of this year, although spending on goods slowed, suggesting underlying demand indicators remain resilient.
Capital Economics chief economist Paul Ashworth explained on Thursday that rising U.S. imports relative to exports also significantly reduced GDP growth in the first quarter, masking signs of underlying economic momentum.
“Exports ended up increasing by just 0.9%, illustrating the impact of weak global demand, while imports grew by 7.2%,” he explained. “Overall, net exports subtracted almost 0.9% of a point from GDP growth, with inventories creating an additional drag of almost 0.4% of a point.”
Those caveats mean there was likely more strength in the economy than first-quarter GDP growth figures indicated. That’s a good sign for consumers and businesses, but it will also keep the Fed from cutting interest rates – at least “for now, demand is generally fine, but inflation is still uncomfortably high,” William Blair’s de Chazal said.