News & analysis

The advance reading of US Q1 GDP today showed the economy slowing more than expected. Headline GDP landed at 1.6% QoQ annualised, down from 3.4% in the fourth quarter and significantly below expectations of 2.5%.

Behind the decline was a slump in personal consumption, which fell from 3.3% to 2.5% QoQ annualised to undershoot expectations by 0.5pp, along with weaker exports (+0.9%, down from +5.5% in Q4), and state and local government spending (+2.0%, down from +6.0%). On the surface, this poses a significant challenge to the current market view that the strength of the US economy will lead to greater inflation persistence and a later commencement to a more gradual Fed easing cycle. However, the topline figures don’t actually reflect the true strength of the economy, or of US inflation, with the details of today’s report exhibiting considerably more strength on both scores.

Turning first to the determinants of growth, the slowdown in personal consumption was entirely driven by spending on goods, which contracted outright in Q1 by -0.4% after recording growth of 3.0% in the fourth quarter.

Services consumption, on the other hand, actually accelerated from 3.4% to 4%. The components of services consumption also showed the consumer remained in good health, with spending on recreational services adding 0.12pp, up from an average contribution of 0.075pp in 2023, as the consumer spent an increased share of its larger disposable income. This was evidenced by the personal savings rate falling from 4% in 4Q23 to just 3.6% last quarter, while real personal disposable incomes continued to increase, this time at an annualised pace of 1.1%. In fact, the only drag in consumer spending in the first quarter occurred in food and accommodation services, which in isolation remains less concerning given how volatile this component has been on a quarterly basis in the post-pandemic period. Moreover, the drag from goods consumption stemmed from just two components, motor vehicles and parts (-0.25pp drag on headline GDP) and gasoline and energy goods (-0.19pp drag on headline GDP). However, we doubt spending was that weak in these components either, with the real growth impact instead being driven by strong PCE deflators for these specific components, which we expect to be confirmed by tomorrow’s March PCE report.

Analysing just the components of personal consumption in the first quarter, the markets’ worst fears around inflation dynamics have seemingly been confirmed.

Tight labour market conditions are fuelling further increases in real disposable income which is being spent at an increased pace because the consumer feels secure with their employment and isn’t being deterred by significant price increases. That said, inflation didn’t actually ease in the first quarter either. Core PCE rose to 3.7% in Q1, almost double the 2.0% growth rate seen in both Q3 and Q4 of 2023. While markets had been positioned for a rise in core PCE given the stronger outturns in the monthly data for January and February, the actual increase surpassed expectations by 0.3pp. This is likely to concern Fed officials, especially given the source of today’s upside surprise – the PCE index for services jumped from 3.4% in Q4 to 5.4% in Q1. Not only does this mark the highest rate seen since Q1 2023, it points towards domestic factors as being the primary driver of resurgent price growth in the US economy. That said, today’s report was not all bad news on the inflation front. Both durable and nondurable goods PCE indices fell in the first quarter. Moreover, the market based core PCE measure, which excludes most implicit prices, also told a much less alarming story than the headline measure, rising to 3.1%, up from 2.3% in Q4. Even so, this might be clutching at straws.

The overall story told by today’s PCE data is still one of sticky inflation. As far as the GDP data goes, this meant that the implicit price deflator jumped from 1.7% in Q4 to 3.1% in Q1, marking a significant contribution to the headline undershoot in overall growth. As a result of the strength of today’s PCE deflator, the odds for tomorrow’s March PCE release strongly skew towards an upside miss to expectations of a 0.3% MoM print.

Markets are already preparing for just this eventuality, delaying their expectations for the first full rate cut by two meetings to December.

This means markets are pricing just over one rate cut this year from the Fed, a considerable turnaround from the 3 rate cuts priced just one month ago after the last meeting. For FX markets, the playbook remains the same. With the Fed unlikely to move before the very end of summer at the earliest, the dollar continues to reign supreme, especially as significant levels on Treasury yields have now been broken (5% on the 2-year and 4.7% on the 10-year), inducing another round of significant equity weakness. We doubt this narrative is going to change anytime soon, especially across next week’s Fed meeting, although a cooling in April’s jobs figures next Friday could provide the first bit of cold water on what is a piping hot US economic outlook should leading indicators prove correct.

Expectations of the Fed’s easing cycle get smashed once again, with close to two rate cuts now priced out since last month’s meeting 



Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst


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