4/26/24 – Solid US Economic data supports higher interest rates for longer theme

On the back of strong retail sales in the last three months we were expecting that the first pass of Q1 GDP would come in above expectations.  When the results were released yesterday, the tally fell well below the 2.5% consensus expectation, showing that annualized growth slowed to 1.6%.  Digging through the details yielded a mixed conclusion.  Personal spending, the main driver of growth, rose 2.5%, below the 3% consensus expectation, but still supportive of the view that consumers continue to spend.

Subtracting from GDP was the sharp spike in imports.  In Q1 imports grew at an annualized pace of 7.2%, the strongest growth since Q3 2022. In the calculation for GDP, imports subtract from growth, meaning GDP would have been higher had the import number been excluded.  But it’s also a sign of strong consumer demand.

The final surprise in the GDP report was the personal consumption deflator, ex food and energy.  That’s the inflation index that the Fed has touted as their bogey for inflation.  The Fed collectively declared victory when the Q4 measure totaled 2.0% but the same measure for Q1 registered 3.7%, clearly in the wrong direction for the committee.  That number paired with the stubbornly high inflation rate as measured by the Consumer Price Index will reinforce the belief that the Fed will not be able to cut interest rates anytime soon.

Further illustrating the problem inflation is posing was the University of Michigan inflation expectations for the coming 12 months, which rose to 3.2%, the highest it’s been since last November.  Clearly respondents are questioning the concept that inflation has been conquered.

That economic data weighed on bond yields this week, with the 2-year note briefly trading above 5% for the first time since last November, and the 10-year note closing the week just shy of 4.70%, also the highest it’s been since last fall.

Next week is likely to be a volatile one with the conclusion of the FOMC meeting on Wednesday and the April employment report on Friday.  The FOMC is widely expected to leave rates unchanged, but traders will be eager to hear how the committee views any changes to the overnight interest rate in the coming months, especially given Q1’s economic strength.

The expectation for non-farm payroll growth is 250,00 jobs added for the month, which would represent another above trend level of job creation.  The unemployment rate is expected to remain at 3.8% and average hourly earnings are expected to total 4.0% year-over-year.