Mixed bag due to GDP release

The latest report from the US economy – featuring new readings on growth, inflation, spending and wages over the first three months of the year – is expected to include a mix of good and bad.

The overall measure of economic growth in the first quarter – due out this morning – will look weak or even negative as a soaring trade deficit and slower inventory growth masked strong consumer spending. Income gains in March were likely wiped out by an acceleration in inflation.

Resilient consumption, robust business investment, firmer wage growth and the fastest price gains in decades support a more aggressive policy response from the Federal Reserve next week, as authorities are expected to raise interest rates. maximum interest since 2000.

But ultimately, the numbers are retrospective. How the economy weathers persistent inflation, declining fiscal support, rapid interest rate increases and any potential shocks in the year ahead is far from certain. The Fed has a tough job to do: slow the economy enough to bring inflation under control, but not so much as to cause a recession.

Gross domestic product is expected to have grown at an annualized pace of just 1% in the first quarter, marking a rapid slowdown from the 6.9% pace at the end of 2021. But the deceleration will largely reflect a faster pace. slow inventory growth and a larger trade deficit, rather than weakening consumer and business demand.

“This headline is going to be misleading,” said Sarah House, senior economist at Wells Fargo & Co. “Overall, the details will show it’s another strong quarter.”

Data released on Wednesday showed that merchandise imports jumped in March. The wider trade deficit is expected to dampen growth more than initially expected. Stephen Stanley, chief economist at Amherst Pierpont Securities, revised his GDP estimate down to -0.3% after the data, noting that net exports could subtract up to four percentage points from growth in the first quarter. .

Going forward, businesses will continue to replenish inventory, with fluctuations from quarter to quarter. Meanwhile, net exports will likely continue to dampen growth for the rest of the year, given that “the U.S. economy is much stronger than what we’re seeing globally,” House said.

As for the consumer, “they are spending with a little more discretion than they were – say six months ago – but they are still spending,” said Gregory Daco, chief economist at Ernst & Young.

Buoyed by a tight jobs market, strong wage gains and remaining savings from trillions of dollars in government stimulus, Americans continue to dole out cash for a variety of goods and services despite winds increasing opposites. Economists expect consumer spending to have grown at an annualized 3.5% in the first three months of the year, which would be the fastest pace in three quarters.

“Weak exports amid slowing global growth, coupled with robust imports due to strong domestic demand and the dollar, have created a large trade deficit. At the same time, excessive inventory accumulation in the early of the year likely led to a slowdown in inventory restocking in the first Consumer and business spending pick up at the start of the second quarter, which we expect will keep GDP growth above trend for the year,” economists Eliza Winger and Yelena Shulyatyeva wrote in a note for Bloomberg Economics.

Pent-up demand should help support spending in the months ahead as households increasingly spend on services such as travel and restaurants. But a variety of factors, including persistent inflation, higher interest rates and a fragile global environment, will cause spending growth to moderate over the course of the year.

“It’s a robust economy today, but one in which economic momentum will cool as we move forward into 2023,” Daco said.

In the meantime, inflation has reached its climax. The Fed’s preferred inflation measure, released on Friday, is expected to have risen 6.7% in March from a year earlier. After adjusting for price increases, personal income and spending likely fell last month.

And while wages are rising at a rapid pace – as the latest Employment Cost Index figures are likely to strengthen on Friday – they are not keeping up with inflation overall. Compared to a year earlier, real average hourly earnings have fallen for 12 straight months.

Tax refunds, which are up about 8% from a year ago, and the remnants of the expanded child tax credit should help bolster revenues. However, households must increasingly rely on their savings to spend at the current rate. The savings rate is just above an eight-year low.

“Even if we remove some of the gas price increases, we still face the problem of our income not keeping pace with consumption and something is going to have to give,” said Stephen Gallagher, chief US economist at Societe. . General.

And low-income households will disproportionately feel the brunt of the pressure.

“A significant portion of the consumer sector is going to be affected,” Gallagher said. “The average may be good, but it glosses over the fact that a significant portion of these households face tough times ahead.”

But a key piece of the puzzle is what happens to the pace of wage growth. Ethan Harris, head of global economics at Bank of America Corp., expects a tight labor market to change the picture “from a world of people squeezed to wages outpacing prices” later this year, which would help consumption hold up despite rising costs.

The downside is that it would also put persistent upward pressure on inflation and risk a heavier Fed response.

The ECI – a key measure of wage inflation and a key reason for the Fed’s more aggressive pivot last year – is expected to rise at a pace of 1.1% in the first quarter. It would be the third consecutive increase of 1% or more, the longest such period since 2001.

“This is a potentially longer-lasting source of inflation,” Wells Fargo’s House said. “If you get another surprise on the ECI, that could further cement how many 50 basis point hikes we could get and how quickly the Fed looks to get back to neutral.”

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