New data released on Thursday has left economists surprised, as it revealed signs of ongoing inflation and a slowdown in the growth of the United States’ real gross domestic product (GDP). According to the Bureau of Economic Analysis, the first quarter saw a meager 1.6% increase in GDP compared to the previous year. This figure fell short of economists’ expectations of 2.5% growth and marked a significant decline from the 3.4% growth seen in the fourth quarter of the previous year.
The core personal consumption expenditures (PCE) price index, a key inflation gauge favored by the Federal Reserve, experienced a significant surge. In the first quarter of this year, it rose from 2% in the fourth quarter of 2023 to 3.7%. This increase easily surpassed the 2.1% inflation that was predicted by the Survey of Professional Forecasters in February.
David Donabedian, chief investment officer of CIBC Private Wealth U.S., expressed his perspective on the report, describing it as the “worst of both worlds.” According to him, the report indicated slower growth than anticipated and higher inflation levels than expected. In an email response to Fortune, Donabedian shared his insights on the matter.
According to Donabedian, the surge in core inflation, especially in the services sector, is the main setback. Consumer prices in this sector are increasing at an annual rate of over 5%. This poses a challenge for Fed Chair Jerome Powell and other central bankers who were hoping for inflation to subside so that they could lower interest rates and stimulate the economy. Donabedian believes that this new data will lead to a situation where investors no longer expect any rate cuts. As a result, Chair Powell will have to adopt a more hawkish tone for the upcoming FOMC meeting.
In a note published on Thursday, Citi economists, led by Veronica Clark, expressed a similar view, suggesting that the Federal Reserve’s preferred inflation measure is expected to increase to 2.8% when the March data is released on Friday. This upward trend in inflation could potentially push central bank officials towards a more hawkish stance. As a result, Clark and her team now anticipate the first interest rate cut to take place in July, rather than June. However, she emphasized that the markets may be mistaken in completely ruling out any rate cuts for the remainder of the year.
As the fiscal stimulus support diminishes and consumer spending on goods weakens, the Federal Reserve will face the challenge of economic growth concerns when determining whether to lower or maintain interest rates. According to Clark, “We still anticipate that the Fed will implement rate cuts this summer, even before inflation experiences a sustainable slowdown.”
Investors showed a clear focus on the persistent inflation evident in the first quarter GDP report on Thursday. Their enthusiasm for market-boosting rate cuts this summer seemed to wane. By midday Thursday, the Dow Jones industrial average dropped 1.5%, the S&P 500 fell 1.1%, and the tech-heavy Nasdaq Composite plummeted 1.5% as investors absorbed the implications of the GDP report.
According to EY chief economist Gregory Daco, the first quarter GDP report has undermined the theory of a “no landing” scenario for the U.S. economy. This new outlook, adopted by many leading Wall Street forecasters and economists, predicted stronger economic growth and slightly higher inflation. Daco argues that the report has debunked the misleading narratives of a reaccelerating economy. He shared his views with Fortune via email, stating that the report has poured cold water on these optimistic projections.
Daco expressed his belief that there will be a further slowdown in economic growth during the second quarter. This is due to persistent inflation, strict credit conditions, and a decline in labor demand. He also emphasized that if inflation remains higher than expected, it could have a significant negative impact on the economy. This includes reduced real income growth, an extended period of higher interest rates from the Federal Reserve, and tightening of financial conditions.
According to David Russell, the global head of market strategy at TradeStation, the U.S. economy might be on the verge of a nightmarish economic scenario not seen since the 1970s.
“According to an email statement to Fortune, the growing risk of stagflation is becoming apparent after the GDP fell short of expectations and the price index unexpectedly rose. The concern arises from the fact that if inflation remains high despite weak economic growth, there is uncertainty about whether the trend of declining prices will persist. This viewpoint is further supported by JPMorgan Chase CEO Jamie Dimon, who emphasized in an interview with the Wall Street Journal that stagflation is a risk that cannot be overlooked by the Federal Reserve.”
A caveat to the weak GDP data
The weak growth statistics from the first quarter GDP report are undoubtedly a cause for concern. However, it is important to note some caveats that shed a different light on the situation. Specifically, private domestic demand, which measures real final sales to domestic purchases, actually experienced a 3.1% increase during this period. Richard de Chazal, an analyst from William Blair, finds this growth in real private domestic investment to be encouraging. He explains that it is a strong leading indicator for future near-term GDP growth in a note published on Thursday.
In the first few months of this year, there was a noticeable increase in spending on health care, financial, insurance, and other services. This indicates that despite a slowdown in spending on goods, there is still a strong demand for these essential services.
According to Paul Ashworth, Chief North America economist at Capital Economics, the United States experienced a decrease in GDP growth in the first quarter due to the significant rise in imports compared to exports. This overshadowed the signs of underlying economic strength.
According to the expert, weak global demand had an impact on the modest 0.9% increase in exports, while imports experienced a significant surge of 7.2%. As a result, net exports had a negative impact of almost 0.9% points on GDP growth, with inventories contributing an additional drag of nearly 0.4% points.
The first quarter GDP growth figures may not fully reflect the true strength of the economy due to certain limitations. However, this is actually a positive indication for both consumers and businesses. Despite this, the Federal Reserve will likely refrain from lowering interest rates in the near future. As William Blair’s de Chazal pointed out, although demand remains generally stable, inflation still remains uncomfortably high.
