The downshift could mean the Federal Reserve cuts interest rates sooner than had been expected.
In what could be the first significant sign the U.S. economy may be slowing from the weight of higher interest rates, gross domestic product grew at an annual rate of 1.6% in the first quarter.
That is well below the 2.2% consensus forecast and comes after a string of hotter-than-expected GDP reports dating back to last fall.
“The increase in the first quarter primarily reflected increases in consumer spending and housing investment that were partly offset by a decrease in inventory investment,” the report from the Bureau of Economic Analysis said. “Imports, which are a subtraction in the calculation of GDP, increased.”
“Compared to the fourth quarter, the deceleration in real GDP in the first quarter primarily reflected decelerations in consumer spending, exports, and state and local government spending and a downturn in federal government spending,” the BEA said. “These movements were partly offset by an acceleration in residential fixed investment. Imports accelerated.”
The economy grew by 3.4% in the fourth quarter of 2023.
Although the report means that consumers are continuing to spend, the deceleration in economic activity, if it continues, could mean the Federal Reserve will be able to cut interest rates sooner as it tries to bring inflation down to its 2% target. That would make borrowing costs on everything from car loans to credit cards and home mortgages easier for consumers to handle.
“The GDP missing expectations this quarter may be a sign that the economy is finally reacting to the ongoing interest rate hikes we saw over the past year,” said Steve Rick, chief economist at TruStage. “For the first time in a while, we are seeing consumer spending begin to fall as inflation remains high. We expect that this quarter’s GDP results will encourage the Fed to move forward with their expected rate cuts later this year, helping the economy to further stabilize.”
The report comes a day before the government releases a key inflation metric, the personal consumption price expenditures index, that is followed closely by the Federal Reserve. Economists are looking for a monthly gain of 0.3% and an annual rate of 2.6%. The core index that strips out food and energy costs is expected to show inflation at a 2.7% annual rate, down slightly from February.
The Fed meets next week to consider interest rate policy, with most analysts expecting no change in the level of rates that are at the highest levels in two decades.
Markets have been choppy recently as they adjust to the idea the Fed may not lower rates until late summer or early fall and also after tech leader Meta issued weak guidance in its earnings report. Two other tech bellwethers, Microsoft and Google, are set to release earnings after the market closes Thursday.
A group of tech stocks known as the Magnificent 7 have been largely responsible for the huge runup in stocks during the first quarter, but any slowdown in their growth could spark broader concerns about the overall economy.
Dow Jones Industrial Average futures fell by 400 points after the GDP report was released.
“Today’s report gives (Fed Chairman) Jerome Powell breathing room on when to begin rate cuts later this year,” said Damian McIntyre, portfolio manager at Federated Hermes. “Although the report was below expectations, markets should feel comforted that the economy is not at risk of overheating.”
Separately, the National Association of Realtors said on Thursday that pending home sales – a measure of contract signings that usually become full sales in a month or so – rose by 3.4% in March, above estimates for a slight gain. The increase follows a 1.6% gain in February,
Despite high mortgage rates, demand for homes remains strong as inventory of existing homes for sale is being held back by homeowners who are sitting on low-rate mortgages taken out a few years ago during the pandemic.
“March’s Pending Home Sales Index – at 78.2 – marks the best performance in a year, but it still remains in a fairly narrow range over the last 12 months without a measurable breakout,” said NAR Chief Economist Lawrence Yun. “Meaningful gains will only occur with declining mortgage rates and rising inventory.”
“Home sales have lingered at 30-year lows, and since 70 million more Americans live in the country now compared to three decades ago, it’s inevitable that sales will rise in coming years,” explained Yun. “Inventory will grow steadily from more home construction, and various life-changing events will require people to trade up, trade down or move to another location.”