What Do the Q1 GDP and Inflation Results Mean for Markets?

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Two key pieces of economic information came out on Thursday, and neither proved to be very good for the stock markets.

First, the U.S. Bureau of Economic Analysis (BEA) released the first-quarter gross domestic product (GDP) on Thursday, which showed that economic growth slowed more than expected. The GDP came in at 1.6%, which was lower than the consensus estimate of 2.4% for Q1 by economists. It was also the lowest growth rate since the second quarter of 2022, when the GDP contracted.

While the official Personal Consumption Expenditures (PCE) results for March won’t be released until Friday morning, there were some other clues in the GDP report that suggested the Federal Reserve’s key inflation gauge may have ticked up in March.

As a result, Thursday was not a good day for the markets, as the major indexes were all in the red, led by the Dow Jones Industrial Average. As of 1 p.m. Eastern, the Dow was off by 470 points, declining 1.2%.

Slowest GDP growth since 2022

So far, the Federal Reserve has been able to navigate the economy toward its intended soft landing, meaning the central bank may be able to get inflation down without sending the economy into recession. However, the first-quarter numbers reveal that while the economy has cooled, inflation could be heading back up.

First, let’s look at the Q1 GDP. At 1.6% growth, it is expanding more slowly than it did in Q4 when the GDP was at 3.4%.

The drop in GDP growth compared to Q4 is due primarily to slowing consumer spending, exports, and state and local government spending. The downturn in federal government spending hasn’t helped either.

These moves were partially offset by increases in residential fixed investment, which reflected an increase in home sales and new housing construction. Imports also accelerated in the quarter.

While a slowing economy is a concern, the larger issue appears to be the inflation rate. Earlier this month, the Consumer Price Index (CPI) reading for March showed that inflation had increased 3.5% over the past 12 months — up from 3.2% in February.

The March reading for the Fed’s preferred inflation gauge, the PCE Index, is scheduled for release on April 26. However, in its GDP report, the BEA posted first-quarter PCE numbers, which lends some insight into what we could see in March.

Could the March PCE Index tick higher?

The PCE for Q1, which includes January, February and March, increased 3.4%, compared to 1.8% in the fourth quarter of 2023. Excluding the more volatile food and energy prices, the PCE index increased 3.7% in the first quarter, compared to an increase of 2% in Q4.

The PCE Index readings from January and February were 2.4% and 2.5%, respectively. Thus, a first-quarter reading of 3.4% suggests that the March number should be considerably higher — unless the January and February numbers were adjusted up. We will find out for sure on Friday, but on Thursday, the market took this as a bad sign.

According to Reuters, Olu Sonola, head of U.S. economic research at Fitch Ratings, noted that the combination of a slowing economy and rising inflation is a recipe for the Fed to potentially wait longer than expected to lower rates.

“The hot inflation print is the real story in this report. If growth continues to slowly decelerate, but inflation strongly takes off again in the wrong direction, the expectation of a Fed interest rate cut in 2024 is starting to look increasingly more out of reach,” Sonola told Reuters.

Investors will certainly be watching out for Friday’s PCE report for more insight into what the Fed might do. It had been widely anticipated that the central bank would enact three rate cuts in 2024, with the first potentially coming in June or July. However, if inflation continues to trend upward, many economists estimate that the first cut might not come until September.