The U.S. economy remained robust earlier this year, with a strong labor market leading to robust consumer spending. The problem is that inflation has also been resilient.
Inflation-adjusted gross domestic product rose 1.6 percent annually in the first three months of the year, the Commerce Department said Thursday. That was a significant decline from the 3.4 percent growth rate at the end of 2023 and fell well short of forecasters’ expectations.
Economists were largely unfazed by the slowdown, which was largely due to big changes in business inventories and international trade, components that often fluctuate wildly from quarter to quarter. Underlying demand metrics were significantly stronger and offered no indication of the recession that forecasters had warned about for much of last year.
“It suggests some moderation in growth but still a solid economy,” said Michael Gapen, chief U.S. economist at Bank of America. He said the report contained “few signs of weakness overall.”
But the solid growth figures were accompanied by an unexpectedly rapid acceleration in inflation. Consumer prices rose 3.4 percent annually in the first quarter, compared to 1.8 percent in the final quarter of the previous year. Excluding the volatile food and energy categories, prices rose 3.7 percent annually.
Overall, the first-quarter data was the latest evidence that the Federal Reserve’s efforts to contain inflation have faltered – and that financial markets’ joy over what appears to be a “soft landing,” or gentle slowdown, in the economy is premature was.
“It increases the chances of a harder landing,” said Constance L. Hunter, an economist at MacroPolicy Perspectives, a forecasting firm. “The inflation data was the surprise.”
At the very least, stubborn inflation is likely to mean that the Fed will wait until at least the fall to cut interest rates. Some forecasters say it’s possible that policymakers will not just keep interest rates “higher for longer,” as investors have been expecting for several weeks, but raise them even further.
“It’s a huge shift because suddenly ‘higher for longer’ could mean another rise,” said Diane Swonk, chief economist at KPMG. Currently, she said, the Fed is stuck in “monetary policy purgatory.”
Financial markets fell on this news. The S&P 500 index fell about 1 percent at midday and Treasury yields rose as investors expected borrowing costs to remain high.
It’s not just investors who could suffer if interest rates remain high. There is growing evidence that high borrowing costs are hurting Americans’ financial well-being. Consumers saved just 3.6 percent of their after-tax income in the first quarter, down from 4 percent at the end of last year and more than 5 percent before the pandemic.
The symptoms of stress are particularly severe in households with lower incomes. They are increasingly turning to credit cards to pay their expenses and with high interest rates, more and more of them are falling behind on their payments.
“There is a sense that lower-end households are under increasing pressure right now,” said Andrew Husby, senior U.S. economist at BNP Paribas.
But despite these pressures, overall consumer spending shows little sign of slowing. Spending rose 2.5 percent annually in the first quarter, only slightly slower than at the end of 2023, and spending on services like travel and entertainment actually increased.
The spending has been driven largely by wealthier consumers, whose low debt levels and fixed-rate mortgages protect them from the impact of higher interest rates and who have benefited from a stock market that until recently was at records.
“Higher-income households feel very wealthy,” said Brian Rose, senior economist at UBS. “They have seen such a huge increase in the value of their home and their portfolio that they feel like they can keep spending.”
That presents a conundrum for Fed policymakers: its main anti-inflation tool, high interest rates, does little to curb spending by the rich while hurting poorer households. And yet if they cut these rates, inflation could rise again.
Still, forecasters say the overall economic picture remains surprisingly rosy, especially compared to the dire forecasts of a year ago. Unemployment remained low, job growth remained strong and wages continued to rise, helping after-tax income outpace inflation in the first quarter.
Companies increased their investments in equipment and software in the first quarter, a vote of confidence in the economy. The housing market also recovered, although this was partly due to a decline in mortgage rates, which has since been reversed.
Even one of the drags on growth in the first quarter – a widening trade deficit – largely reflected demand from the United States. Imports rose as Americans bought more goods from overseas, while exports rose more modestly.
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2024-04-25 17:53:40
www.nytimes.com
