Just last Friday, the official website of the U.S. Department of Commerce disclosed that according to estimates, the seasonally adjusted annualized growth rate of real gross domestic product (GDP) in the first quarter of 2024 will be 1.6%, which is significantly narrower than the 3.4% value in the fourth quarter of last year. Previously, the market expected US GDP growth of 2.5% in the first quarter.

Does the recent data point to an increased risk of stagflation in the US?

Based on the fact that the US GDP in the first quarter was lower than expected, but PCE inflation was higher than expected, some market participants are worried about the increased risk of US stagflation.

Over time, the suppression of demand by high interest rates will eventually lead to a slowdown in price growth, which means that inflation will not continue to fluctuate at current levels, and GDP growth will most likely not enter negative territory. This means that the U.S. economy will not stagnate significantly, nor will it continue to expand. The GDP and inflation data for the first quarter show that the United States is not currently "stagflation", but more of a "stagflation" characteristic.

On the one hand, the core economic momentum of the United States in the first quarter remained stable and did not show signs of "stagnation". In absolute terms, US real GDP grew at an annualized rate of 3.0% in the first quarter, compared with 3.1%, 2.9% and 2.4% in the previous three quarters , far from the level of "stagnation".

From a structural point of view, GDP in the first quarter was mainly dragged down by the high growth of imports, and net exports pulled down GDP by about 0.9 percentage points, which was the biggest drag on GDP. In addition, changes in inventories dragged down GDP by about 0.4 percentage points. However, the "core GDP", which reflects real domestic demand, i.e. consumption + fixed asset investment (after excluding imports and exports, inventory changes and government spending), was 3.1% quarter-on-quarter, only slightly down from 3.3% in the previous quarter, of which consumption still grew by 2.5%, and the growth rate was still at a high level. This shows that the core economic momentum of the United States remains solid. In addition, historically, the annualized rate of U.S. GDP in the first quarter is often the lowest point of the whole year, mainly due to the seasonal decline in private consumption and inventories in the first quarter, which reflects factors such as holidays and weather.

On the other hand, the core PCE in the United States in the first quarter significantly exceeded expectations, and the characteristics of "inflation" were more obvious. This is the most worrying issue for the market. In the first quarter, the annualized rate of core PCE rebounded by 1.7 percentage points from the previous quarter to 3.7%, of which the commodity price index fell by 0.5% quarter-on-quarter, maintaining the deflationary trend, but the services quarter-on-quarter annualized rate was 5.4%, a sharp increase of 2 percentage points from the previous quarter, highlighting that service inflation is still sticky. On the whole, the total PCE data for the first quarter has been determined and higher than expected, highlighting the characteristics of "inflation".

Overall, the U.S. economy is growing steadily despite monetary policy constraints. At the same time, there is a risk that inflation will stagnate, falling into higher levels than previously expected. Strong domestic demand and upwardly revised inflation suggest that the Fed will be more patient in terms of policy adjustments.

|What will be the direction of the policy?

In recent months, inflation in the United States has exceeded expectations many times, and inflation has shown some resilience.

At present, the above inflation problem is mainly due to the relatively abundant cash in the hands of consumers and small and medium-sized enterprises due to large-scale subsidies by the US Treasury during the three years of the epidemic, and high interest rates have not suppressed their demand for goods and services through high borrowing costs. However, this effect has come to an end, and the dampening effect of high interest rates on the economy is emerging. In the future, economic growth will slow down and inflation will fall further.

Judging from the inflation data in recent months, services inflation is sticky, which is the main reason for the larger-than-expected headline inflation. The stickiness of services inflation is mainly due to the following points:

First, the labor market is strong, the current labor market has not cooled significantly, the unemployment rate is in a historically low range, and the growth rate of household wages has supported private consumption. Against the backdrop of a clear shift in consumer demand from goods to services in the United States, consumer spending on services remained resilient.

Second, the U.S. capital market performed well in the first quarter, supporting financial services and insurance prices, and third, the housing market rebounded in the first quarter, driving housing inflation down. However, the overall trend of PCE prices gradually falling year-on-year has not changed, at 2.8% in February, compared with 3.4%, 3.2% and 2.9% in the previous three months. The March PCE data also showed a certain stickiness.

Inflationary pressures in the United States are spilling over globally

The Fed's protracted war against inflation has made it more difficult for other central banks to pivot to easing. If other central banks cut interest rates more aggressively than the Fed, they could hurt their own economies due to the impact of exchange rates, import costs, and inflation.

In the case of the European Central Bank and the Bank of England, two central bankers believe that they do not face the same severe inflation problem as the United States, which means they have more room to cut interest rates. Although investors expect the Fed to cut interest rates for the first time in November, senior officials at the European Central Bank and the Bank of England have hinted that they will cut rates this summer.

ECB President Christine Lagarde said in Washington this month that the "root causes and drivers" of inflation in the eurozone and the US are different – Europe is more affected by energy costs, while the US is largely affected by fiscal deficits. Bank of England Governor Andrew Bailey also believes that inflation dynamics in Europe are "somewhat different" from those in the United States.

But the changes in the futures market show the global impact of the ongoing U.S. inflation problem.

In early May, the Federal Reserve will usher in the latest interest rate decision

After the release of the Q1 GDP and PCE inflation data, the resilience of the economy will further raise the threshold for future interest rate cuts by the Fed, which means that the Fed's rate cut will be further delayed. In fact, the current consensus expectation is that the Fed may not cut interest rates until after September, and some Fed officials are even discussing the possibility of raising interest rates.

GDP growth has declined recently, but it is still in a good positive range, and the inflation rate has been volatile and may even rebound, so it is judged that the Fed will still keep interest rates unchanged. Based on the current trend, it is unlikely that interest rates will be cut before September.

The Fed is expected to adopt a hawkish stance. Fed Chair Jerome Powell will hint that the data suggests that rate cuts will come later and that the number of rate cuts will be reduced.