Slowing growth and the stubborn inflation picture emerging in the US economy may not be a nightmare scenario for the Federal Reserve, but it could at least give it some restless sleep. First-quarter results released Thursday showed the U.S. economy slowing at an annual rate of 1.6%, the slowest in nearly two years, and inflation nearly doubled from the previous quarter and at the highest level in a year. Together, the two data points point to at least a moderate inflationary environment that will make policymaking troublesome in the coming weeks and months. “It was clearly not expected. I think it may have been delayed,” Matthew Ryan, head of market strategy at global financial services firm Ebori, said of the Commerce Department's GDP report. “We've seen a U.S. economy that has not only defied expectations, I would say defied conventional logic in recent months and grown at a very strong pace that you would think was perhaps not achievable at this depth and long after the Fed started raising interest rates. ” Markets were looking for a continuation of the string of good readings dating back to mid-2022, with economists estimating real GDP growth at 2.4% and inflation readings at around 3%. What I got was essentially what some on Wall Street described as the worst of both worlds, with weak growth and stubborn price pressures. As a result, stocks sold off sharply, Treasury yields rebounded, and futures traders were forced – once again – to reprice their expectations for federal funds rates. After starting the year expecting at least six cuts, the market is now down to one cut, with another implied cut off the table, according to CME Group's FedWatch tracker, which tracks possibilities based on federal funds futures. While there may be some logic in believing that the Fed might view a slowing economy as conducive to policy easing, Ryan said officials are likely to closely study data on the Personal Consumption Expenditures Price Index, their preferred measure of inflation. . During the first quarter, headline PCE rose at an annual pace of 3.4% for all items and 3.7% for the core measure that excludes food and energy costs. The Fed will take a more detailed look at personal consumption expenditures data on Friday when the Commerce Department releases monthly numbers for March. “I don't think the Fed will be too impressed by a slightly weaker-than-expected GDP number, and even the 1.6% annual data is not an absolute disaster. It's still a fairly strong growth number,” Ryan said. “The Fed will be more interested in seeing inflation.” In fact, some comments on Wall Street suggested that the GDP figure was no cause for concern. The weakness came primarily from inventories and federal government spending, while growth “is rebounding in those sectors that reflect improved confidence in the economy moving forward,” wrote Stephen Blitz, chief U.S. economist at TS Lombard. “The calculations don't add up for a weak private sector.” Blitz noted the problem of a strong dollar pushing capital equipment purchases to foreign producers, and the data reflected a decline in GDP due to higher net imports. “What does the Fed do in the face of all this? It remains in place for now, as the likelihood of any cuts this year continues to recede,” he said. “But in the end, this is a real growth story, which is a good thing.” Citigroup, one of the few remaining on the Street that still expects a dovish Fed this year, stuck to its call on Thursday, saying Fed officials would likely be inclined to avoid contracting growth through interest rate cuts and would be encouraged to do so by… During the upcoming decline in inflation indicators. “Concerns about weak growth will be a key factor in the Fed’s cut considerations, and Q1 GDP details show fading support from fiscal stimulus and weak spending on goods,” Citi economist Veronica Clark wrote. “We continue to believe Fed cuts will come this summer, before inflation slows sustainably.”
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Slowing growth combined with stubborn inflation adds to the headache for Fed officials
