A Whiff of Stagflation
The US economy appears to have switched into a lower gear, from the unsustainable levels witnessed in 2023. The advanced reading for the US GDP missed expectations for 2.5% expansion in the first quarter, coming in at 1.6%qoq. A widening trade deficit and a slowdown in inventory accumulation acted as drags on the headline growth figure for the first three months of the year. Although above the longer-run sustainable pace, the growth figure represented the most sluggish rate of expansion in nearly two years. Interestingly, the Atlanta Fed GDPNow model estimates first quarter growth at 2.7%, down from 2.9%.
Personal consumption also surprised to the downside at 2.5%, against expectations for 3.0% and down from 3.3% in the prior quarter. Household spending rose 2.5%, from the robust pace of 3.3% and 3.1% in the two previous quarters; a reading above 2% is considered above average. Meanwhile, spending on services rose at the fastest pace since the pandemic recovery, up 4%qoq.
Meanwhile, the closely watched inflation gauge rose faster-than-expected, adding to the Fed’s woes. The core PCE Index, which strips out volatile food and energy costs, increased 3.7% in the first quarter, and markets expected a 3.4%qoq rise. Later today, market focus will shift to the release of the Personal Consumption Expenditures (PCE) deflator, the Federal Reserve's preferred measure of inflation. This key economic indicator will provide further insights into the prevailing price pressures in the economy. Estimates currently stand at 2.6%yoy on the headline figure, while the core is expected to have marginally eased to 2.7%yoy, in March.
Despite the weaker-than-expected GDP estimate, the US economy remains resilient, and we expect the consumer, coupled with government spending to underpin growth in the medium term. It therefore appears the Fed may not have to cut as soon or as aggressively as previously expected. As it happens, following the data releases, markets dialled back expectations for a cut this year to just one, in November.
In contrast, however, high borrowing costs have posed a significant burden on the housing and manufacturing sectors. Should the Fed maintain its tight monetary policy stance, for an extended period, it could ultimately serve as a drag on the overall economic trajectory.
Expectations of slowing growth, coupled with rising inflation has raised some concerns of early stagflation risks, a term the Fed and politicians, particularly ahead of an election, despise. We wonder whether it is too early to worry about stagflation, given the lack of evidence, currently, of a trend to slow growth and increasing inflation. However, as JP Morgan Chase’s Dimon has repeated this week, the US economy “looks more like the 1970s than we’ve seen before”, adding: “Things looked pretty rosy in 1972 — they were not rosy in 1973”.
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