Consumer spending powered U.S. economic growth over the first three months of the year, data from the Commerce Department indicated Thursday, even as companies slowed production and accelerated job cuts amid concerns for a near-term recession.
Those gains may not last into the back half of the year, however, and with price pressures still elevated, concerns that stagflation will grip the world's biggest economy are starting to materialize.
The U.S. economy expanded at a 1.1% annualized pace over the three months ending in March, according the Commerce Department's first estimate of GDP growth, down from the 2.6% advance over the final three months of last year and notably shy of analysts' 1.9% forecast.
Consumption gains, however, were impressive, with personal consumer spending rising 3.7% offsetting in part a big decline in business investment, which grew by a meagre 0.7%.
U.S. companies also dramatically slowed the rate of goods production over the March quarter, with inventories falling by $1.6 billion compared to the $136 billion gain recorded over the final months of last year as firms reduced capacity, laid-off staff and anticipated softer end demand. The drawdown in inventories clipped -2.3 from the real GDP figure, while consumption added +2.5%
“The largest positive drivers came from a considerable increase in personal consumption expenditures ... driven by unseasonably warm weather during the first two months of the quarter and is consistent with recent improvements in (activity indices)," said Nathaniel Casey, Investment Strategist at wealth manager Evelyn Partners.
“With real GDP growth decelerating further than expected this reinforces our view that US economic growth is likely to continue to slow in the coming quarters," he added. "The delayed effects from the rapid tightening of monetary policy should begin to ease consumer spending and business investment leading to a slowdown in overall economic output.”
The consumption-lead gains have come at a price, however, as the closely-tracked core PCE price index for the first quarter, one of the Federal Reserve's favored inflation metrics, accelerated at a 4.9% pace, topping the 4.4% rate from late last year.
"The last thing the Federal Reserve wants to be doing is raising rates as the economy begins to grind to a halt and potentially exacerbating the situation," said Marcus Brookes, CIO at Quilter Investors. "The coveted soft landing is looking increasingly difficult to achieve and we are now getting towards a position where the market may become concerned that stagflation could be a likely possibility. The next set of inflation statistics are going to be crucial for the subsequent moves by the Fed.”
The CME Group's FedWatch is now pricing in an 85% chance of a 25% basis point rate hike from the Fed next week in Washington, which would take the Fed Funds rate to between 5% and 5.25% and mark the tenth consecutive increase amid the most aggressive policy tightening in at least four decades.
"Despite mass layoffs across industries, we expect unemployment to remain below the natural long-run rate of 4.5% over the next two years," said Steve Rick, chief economist at CUNA Mutual Group. "These factors will hopefully minimize effects of a potential recession but will likely give the Fed leeway to continue to raise rates in next week’s meeting."
Markets remain divided, however, as to whether the Fed will hold that rate into the late autumn months, or begin signaling rate cuts if the economy tips into recession and unemployment rate tick notably higher.
The current economic momentum suggests that may be even further in the future than rate traders anticipate: jobless claims fell by 16,000 to 230,000 last week, according to Labor Department data published this morning, and the headline unemployment rate remains near the lowest in more than five decades at 3.5%.
The Atlanta Fed's GDPNow forecasting tool, meanwhile, pegs current quarter growth at 1.1%, down from the 2.5% pace it estimated on April 18.
"Markets right now don’t like the inflation components in the Q1 report, but they will be forgotten as the labor market falls apart and the sequential core (inflation) prints slow," said Ian Shepherdson of Pantheon Macroeconomics, who notes first quarter consumption was powered in part by warm weather and the 8.7% cost of living adjustment to social security payments introduced at the beginning of the year.
"The economy barely grew in the first quarter, but it is likely to shrink outright in Q2 and Q3," he warned. "Welcome to the recession."
