Rising prices, Falling Growth in US economy: Path to stagflation?

US Sluggish Growth: The most awaited numbers are out, US GDP growth in Q1 was well below estimates at 1.6 per cent, far below that 3.4 per cent in Q4 of FY24. The GDP print at 1.6 per cent, marks a significant slowdown when compared with GDP in Q4.  

The US GDP's slow growth also necessitates the early rate cuts as the economy is not able to put up with the “higher for longer” regime adopted by the US Fed.

Consumer spending, the backbone of the economy, remained robust but showed signs of cooling, potentially impacted by inflationary pressures and a gradual depletion of pandemic savings among lower-income households.

“With a GDP growth rate of 1.6 per cent, which may be below expectations but is still robust enough to dissuade rate cuts, the Fed is likely to maintain its current stance,” Vikas V Gupta, CEO & Chief Investment Strategist, OmniScience Capital said.

However, if the economy appears notably weak, rate cuts could be considered even before inflation moderates. With a GDP growth rate of 1.6 per cent which may be below expectations but is still robust enough to dissuade rate cuts, the Fed is likely to maintain its current stance.

“In response to the unexpectedly high PCE inflation figures, it is now evident that the Fed's ability to act on rate cuts is contingent on a more benign PCE inflation outlook. This scenario supports the "higher for longer" narrative, naturally leading to higher yields.

"A higher core PCE inflation implies that yields will remain elevated until lower inflation figures materialise,” Gupta said.

Stagflation or not

In the latest economic discourse, the U.S. finds itself at a crossroads. On one hand, a flourishing job market and brisk economic expansion have been the hallmarks of the post-pandemic era. Yet, the growth is overshadowed by the persistent spectre of soaring inflation—a conundrum colloquially referred to as "stagflation."

“The latest job claims data indicates a positive trend, with initial applications for unemployment benefits dropping to 207,000 last week, the lowest level in two months.

Continuing claims have also decreased. Consumption has proven to be more resilient than expected, despite predictions that spending would slow as households used up their savings from the pandemic period and borrowing costs remained high,” Gupta highlighted.

The strong labour market has contributed to this resilience, which has increased job opportunities and wages. This has bolstered confidence that the economy is experiencing a "soft landing," where inflation decreases due to higher interest rates without causing a recession.

The US economy faces a dilemma: despite a strong job market and rapid growth, inflation remains stubbornly high. The latest GDP report suggests a potential slowdown in growth alongside continued inflationary pressures, a combination that some fear could lead to stagflation.

However, economists urge caution in interpreting these figures. The slowdown in GDP growth was partly due to increased imports, indicating healthy consumer spending on foreign goods. Additionally, the inflation spike was driven largely by "financial services" costs, influenced by stock market fluctuations rather than broader price trends.

The Federal Reserve's response to inflation, including a series of interest rate hikes since March 2022, hasn't yielded the expected results. Despite rates being at a 23-year high, the economy continues to grow.

All eyes are now on the Fed's upcoming inflation metric release for further insights. However, Fed officials remain cautious, stressing the need for confidence in inflation trends before considering changes to interest rates.