At first glance, it might seem that the Q1 US GDP data released today suggest the Federal Reserve is close to achieving the hoped-for soft landing. The BEA's advance estimate shows that real GDP grew at an annualized rate of just 1.1 percent in the quarter, significantly slower than the 2.6 percent pace recorded in the final quarter of 2022 and well below the markets' consensus estimate of 2.0 percent. However, a closer look at the details of the report indicates that the Fed's job may not be done just yet.
It is clear that the tighter monetary conditions imposed by the Fed over the past year are having an effect on some areas of the economy. The quarter saw a 12.5 percent annualized decline in fixed investment spending, reflecting lower business equipment spending and a further small fall in residential investment, which has now been declining continuously since mid-2021.
These declines were offset by increases in government spending and exports and, most significantly of all, consumer spending. The consumer sector accounts for fully two-thirds of the US economy, a higher proportion than in other developed economies. Despite rising interest rates, real consumer spending accelerated to a 3.7 percent annualized pace in Q1, the strongest print for any quarter since Q2/2021. Durable goods spending rose at a remarkable 17 percent pace, led by vehicle sales.
Given the preponderance of the consumer sector in the economy, the Fed will not be able to assume that it has succeeded in slowing the economy until it sees weaker growth in consumer spending. Today's advance report may of course be revised in subsequent releases -- the next update is due on May 25 -- but the numbers surely lock in the prospect of a further 25 basis point rate hike by the Fed at next week's FOMC meeting.
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