Janet Yellen, US Secretary of the Treasury, former Chair of the Federal Reserve. 2024.

The release of 1st quarter 2024 Gross Domestic Product (GDP) on April 25th surprised virtually all forecasters. The first three months of 2024 were characterized by a notable deceleration in US economic growth, marking an almost two-year low. The same data release revealed that inflation, as measured by US GDP Personal Consumption Core Price Index (quarter-over-quarter), accelerated 3.7 percent, ahead of an expected 3.4 percent, disrupting a brief period characterized by robust demand and subdued price pressures. Those conditions previously fostered optimism for a so-called soft landing. 

The initial estimate of GDP showed an annualized quarterly growth rate of 1.6 percent, falling short of all economists’ predictions (surveys anticipated 2.5 percent). This deceleration was predominantly attributed to a rapid decline of personal consumption, which increased at a slower-than-anticipated pace of 2.5 percent (versus estimates of 3.0 to 3.5 percent). Moreover, a widening trade deficit exerted the most significant downward pressure on US economic growth since 2022. These figures signal a significant loss of momentum after a surprisingly robust economic performance last year. 

Business inventories weighed on growth for a second consecutive quarter, and private capital expenditure remained weak. However, upon excluding the impact of inventories, government spending, and trade, inflation-adjusted final sales to private domestic purchasers — an essential metric for gauging underlying demand — rose at a rate of 3.1 percent. The GDP report further indicated a substantial increase in spending on services, the most significant since the third quarter of 2021, driven primarily by expenditures on healthcare and financial services. But spending on goods declined for the first time in over twelve months, primarily constrained by reduced purchases of motor vehicles and gasoline.

Outbreaks of stagflation, characterized by simultaneously elevated inflation and decelerating economic growth, present a formidable challenge for policymakers. While a recession typically prompts central banks to implement interest rate cuts, stagflation has historically been associated, at least early on, with contractionary monetary policy measures — despite weakening growth trajectories. Recent financial market developments reflect an increasing recognition of this possibility, with options on Secured Overnight Financing Rate (SOFR) futures indicating a 21.4 percent probability of a Fed rate hike by December, marking its highest level since the Federal Reserve signaled the conclusion of its previous rate-hiking cycle. Of note, however, is that another feature of the outbreak of stagflationary conditions — rising unemployment — has not yet actualized. US labor markets are softening, though, and warrant continued monitoring. 

Since the end of the pandemic, there have been periods of economic weakness evoking both the onset of a recession and the emergence of stagflation (“stagflation lite”). In April 2023, we forecast slowing US economic growth possibly leading to a recession by September 2024. Unlike most prognostications, which anticipated a recession by the end of 2023, our more patient position was based upon a number of factors, one of which was the acknowledgement that sizable fiscal stimulus measures could engineer higher GDP readings. (Another was our repeatedly vindicated view that pandemic-era policy distortions could persist for years.) At this juncture, it remains too early to determine whether the first quarter 2024 GDP reading is an isolated bout of weakness or the beginning of a contractionary trend. Presently, it should serve as a stark reminder of the fragility underlying much of the post-COVID economic growth, built as it has been atop the unsustainable pillars of fiscal and monetary stimuli.

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