Final Q1 GDP comes in hot!

Today’s GDP report from BEA reveals surprising strength in the economy, with real GDP increasing at an annualized rate of 2.0 percent. This is a significant upward revision from the second estimate of 1.3 percent.

This increase primarily reflects upward revisions to exports and consumer spending, which were partly offset by downward revisions to nonresidential fixed investment and federal government spending.

The GDP data also shows a deceleration from the fourth quarter of 2022, when real GDP increased by 2.6 percent. This deceleration primarily reflects a downturn in private inventory investment and a slowdown in nonresidential fixed investment.

However, this deceleration was partly offset by an acceleration in consumer spending, an upturn in exports, and a smaller decrease in residential fixed investment.

In terms of inflation, the personal consumption expenditures (PCE) price index increased by 4.1 percent, twice the Federal Reserve's target.

This is an important indicator of inflationary velocity, which the Federal Reserve aims to keep around 2 percent. The PCE price index excluding food and energy prices increased by 4.9 percent, indicating that the inflation is broad-based and not just confined to volatile sectors.

The report also provides insights into the income side of the economy. Current-dollar personal income increased by $278.0 billion in the first quarter, primarily reflecting increases in compensation and personal current transfer receipts. Disposable personal income increased by $587.9 billion, or 12.9 percent, indicating a strong consumer base that could continue to drive economic growth.

The report wasn't all positive, though. Real gross domestic income (GDI) decreased by 1.8 percent in the first quarter, and corporate profits decreased by $121.5 billion. The decrease in corporate profits was seen across domestic financial corporations, domestic nonfinancial corporations, and rest-of-the-world profits.

Once the data was released we saw meaningful changes in expectations regarding Fed policy, with the first cut now priced in for May of 2024, when yesterday it was January.

We can see that overnight change in the expectations for the January meeting shifting materially below.

Key Takeaways

1. GDP Strength: The upward revision of GDP growth to 2.0 percent indicates a stronger economy than initially estimated. This is largely driven by consumer spending and exports, suggesting both robust domestic and international demand. This isn’t good news for the fight against the stickiness of inflation, but it is good news for the economy overall.

2. Inflation Concerns: The PCE price index, a key measure of inflation, increased by 4.1 percent, twice the Federal Reserve's target. We’ll get PCE tomorrow, but we believe a July hike by the Fed is quite likely, and another may be on deck after that.

3. Income Growth: The increase in personal income and disposable personal income suggests a strong consumer base, which is a positive sign for future economic growth.

4. Corporate Profits: The decrease in corporate profits could be a cause for concern. If this trend continues, it could impact future investment and employment growth.

5. Higher for Longer: All of this data makes it clear that the Fed has more work to do. We maintain that they are likely to hike in July and likely at least once more after that.

In closing, we feel that it’s important to monitor ISM Services PMI closely for signs of contraction. It’s clear that the services component of the US economy, which accounts for about 77% of GDP, is helping to support expansion in a meaningful way.

We would need to see three sequential months of relatively meaningful contraction in ISM Services PMI to get a sense that we’re starting to see the economy soften meaningfully. From there we would expect unemployment claims would rise above 300K, and the unemployment rate would climb meaningfully above 4%.

At that point we’d be looking for more signs of imminent economic weakness, leading to a contraction. But we aren’t there yet and today’s data makes it clear that Q1 was a stronger quarter than many expected, particularly because of rising exports, consumer participation in the economy, and government spending.