The U.S. economy expanded at a slower pace than anticipated in the first quarter of 2024, signaling that the Federal Reserve's aggressive interest rate hikes are beginning to weigh on economic activity. According to the Bureau of Economic Analysis's advance estimate, the gross domestic product (GDP) increased at an annualized rate of 1.6%, a sharp deceleration from the 3.4% growth recorded in the previous quarter and below the Bloomberg-surveyed economists' projection of 2.5%.
This modest growth is juxtaposed against a backdrop of rising prices, with core Personal Consumption Expenditures (PCE) - a key inflation measure closely watched by the Federal Reserve - escalating to 3.7% during the quarter, surpassing expectations of 3.4% and the previous quarter's 2% increase. This uptick suggests persistent inflationary pressures despite the central bank's efforts to temper price rises by maintaining high interest rates.
Consumer spending, a critical driver of the U.S. economy, rose by 2.5%, a slowdown from the 3.3% increase in the final quarter of 2023 and falling short of the 3% growth anticipated by Wall Street. The Commerce Department highlighted that fixed investment and state and local government spending provided some support to GDP growth, while declines in private inventory investment and a surge in imports acted as drags.
The GDP price index, another inflation gauge, climbed at a 3.1% rate, indicating that prices across the economy continue to rise faster than desired. "This was a worst of both worlds report - slower than expected growth, higher than expected inflation," commented David Donabedian, chief investment officer of CIBC Private Wealth US.
Markets reacted negatively to the news, with stock futures dropping and Treasury yields increasing, reflecting investor concerns about continued economic challenges. The 10-year Treasury note yield reached 4.69%, the highest since November 2023.
Federal Reserve Chair Jerome Powell, in a mid-April speech, defended the decision to maintain high rates, stating, "Given the strength of the labor market and progress on inflation so far, it's appropriate to allow restrictive policy further time to work and let the data and the evolving outlook guide us." However, this latest GDP report may force the Fed to adopt a more hawkish stance in the near term.
Investors had previously anticipated the Fed might begin to cut interest rates later this year, with futures trading suggesting a reduction as early as September. However, the recent data has adjusted those expectations, with traders now foreseeing fewer and later rate cuts.
Economists are now cautioning that the U.S. economy is likely to face further deceleration in the coming quarters as consumers potentially pull back on spending. "Savings rates are falling as sticky inflation puts greater pressure on the consumer," noted Jeffrey Roach, chief economist at LPL Financial. "We should expect inflation will ease throughout this year as aggregate demand slows, although the path to the Fed's 2% target still looks a long ways off."
The labor market remains a bright spot, with the Labor Department reporting fewer jobless claims than expected for the week ending April 20. Moreover, residential investment surged by 13.9%, the most significant rise since late 2020, offering a glimmer of hope for the housing sector.
