Economic growth appeared much softer in the first five months of the year following the release of key economic data on Thursday. Slower-than-anticipated growth should push the Federal Reserve closer to cutting interest rates.
Read more of RSM’s insights on the economy, manufacturing and the middle market.
We expect a further cooling in the second half of this year, increasing the probability of a policy error if the Fed remains behind the curve once more. We would not be surprised if more downside surprises occur in the coming months if monetary policy is not loosened in time.
While overall GDP was revised up to a 1.4% increase from 1.3%, underlying growth was much weaker, with all key metrics we focused on being materially revised down.
Personal consumption led the drop, growing by only 1.5% instead of 2.0%. Final sales to private domestic purchasers, our preferred metric for non-volatile underlying growth, fell to 2.6% from 2.8%.
Gross domestic income also appeared softer, falling to 1.3% from 1.5% and adding more reason to believe that the labor market was much more balanced than initially thought, given the influx of immigrants, and increasing participation rates in the labor force.
With more data on the labor market suggesting it has normalized to its pre-pandemic level—data that includes the quit rate, vacancy ratios and unemployment—there is less reason for the Fed to keep interest rates unchanged much longer.
Private investment remained the bright spot in the first quarter with a significant upward revision, offsetting some of the disappointment from other key components.
But looking ahead to the second quarter, it is less likely that private investment can continue to drive overall growth, with data on durable goods orders and shipments, especially core capital goods, showing downside surprises in May.
Recent data also pointed to much weaker residential investment spending in the second quarter, another key component of overall investment.
Inside the data
Orders for durable goods increased by 0.1%, yet fell by 0.6% when it comes to the core capital goods component, which excludes defense and aircrafts.
The large drop offset the small increase in April, suggesting much weaker growth in the coming months. For this quarter, core capital shipments also posted a sizable decline, falling by 0.5% after rising by 0.4% in April. Similarly, that should temper any excitement about growth in the non-residential private investment component in the second quarter.
The drop in orders explained why inventories rose in May. Both wholesale and retail inventories rose sharply above forecasts on the month, increasing by 0.6% and 0.7%, respectively.
Inventories were a key drag of GDP in the first quarter. We should expect a rebound in inventories in the second quarter.
In a separate report from the Labor Department, initial jobless claims inched down to 233,000 last week, yet remained at an elevated level compared to a couple of months ago and the average level in 2019, which was at 218,000.
For now, most of the gains might come from seasonal fluctuations, which also happened last year around the same period. But it is important to keep an eye on new claims data as economic conditions are now softer and more susceptible to shocks.
Adding to this view is that continuing claims have reached the highest level since 2021, a sign that unemployed workers have had a much harder time finding new jobs. Continuing claims rose to 1.84 million for the week ending June 15.
