Softer overall demand and inflation in the first quarter should be more of a relief for the Federal Reserve and the market rather than a concern.
Most of the downward revision to gross domestic product data released by the Commerce Department on Thursday came from consumer spending, partly because of the holiday spending hangover that we had predicted, and partly because of the overall cooling of demand for durable goods.
Read more of RSM’s insights on the economy and the middle market.
GDP was revised down to 1.3% from 1.6% earlier, while personal consumption was revised down to 2.0% from 2.5%.
At the same time, the core personal consumption expenditures index, the Fed’s preferred measure of inflation, was also revised down to 3.6% from 3.7%.
Most important, the underlying final sales data remained rock solid, growing by 2.8% in the first quarter. While the excess savings built up during the pandemic might be low for some households, many Americans have continued to enjoy another quarter of strong income growth.
Gross domestic income, another key metric from the report, grew by 1.5%, a testament to the strong labor market in the first quarter. That marks the fifth quarter in a row of growing real income since the first quarter of last year.
We expect total GDP to rebound in the second quarter, ranging between 2.4% to 3.0% as the volatile components such as inventories and net exports show improvement.
On top of that, slower inflation and solid wage growth should be key factors supporting overall spending in the second quarter.
Initial jobless claims, a proxy for layoffs and how tight the labor market is, continue to stay within a healthy margin, signaling a gradually cooling labor market instead of falling off a cliff that many have predicted. New filings inched up last week to 219,000 from 216,000.
The takeaway
Given the recent economic data, we believe the economy is getting close to a soft landing when growth approaches its long-term trend. But we think that the economy post-pandemic will likely arrive at a new place where inflation, while under control, will remain higher than the Fed’s 2% target for much longer than many had expected because of the reasons that monetary policies cannot effectively solve.
If the Fed wants to stay in front of the curve this time, we think rates should be lower sooner rather than later.
