The United States economy slowed considerably during the first quarter of 2023, as interest rate increases and inflation took hold. The gross domestic product (GDP), a measure of all goods and services produced for the period, rose at a 1.1% annualized pace in the first quarter, according to the Commerce Department’s report on Thursday. This was significantly lower than the economists’ Dow Jones survey’s expectation of 2% growth.
The slowdown followed a fourth quarter of 2022 in which the GDP climbed 2.6%, part of a year that saw a 2.1% increase. The personal consumption expenditures price index, an inflation measure that the Federal Reserve follows closely, also increased 4.2%, ahead of the 3.7% estimate. High inflation and slow growth are sometimes described as “stagflation,” which characterized the late 1970s and early 80s U.S. economy.
The report showed that the slowdown in growth came due to a decline in private inventory investment and a deceleration in nonresidential fixed investment. The inventory slowdown took 2.26 percentage points off the headline number. Gross private domestic investment also tumbled 12.5%, while consumer spending as measured by personal consumption expenditures increased 3.7%, and exports were up 4.8%.
Despite the slowdown, stocks initially reacted little to the report, with major indexes pointing to a higher open. Treasury yields increased. However, the GDP report comes as the Federal Reserve is seeking to slow an economy burdened by inflation that had been running at its highest level in more than 40 years.
In a policy tightening regime that began in March 2022, the central bank has raised its benchmark interest rate by 4.75 percentage points, taking it to the highest level in nearly 16 years. Though inflation has pulled back some from its peak around 9% in June 2022, it remains well above the Fed’s 2% goal. Policymakers all say inflation is still too high and will require elevated interest rates.
The U.S. economy is likely at an inflection point as consumer spending has softened in recent months, said Jeffrey Roach, chief economist at LPL Financial. The backward nature of the GDP report is possibly misleading for markets as we know consumers were still spending in January, but since March, they have pulled back as consumers are getting more pessimistic about the future.
In other economic news Thursday, jobless claims totaled 230,000 for the week ended April 22, a decline of 16,000 and below the estimate for 249,000.
Those two issues, the Fed’s rate hiking cycle and an expected credit crunch ahead, are expected to tilt the economy into recession later this year. However, consumers have remained resilient and are expected to use excess savings and purchasing power to make the economic contraction short and shallow. A strong job market, with an unemployment rate at 3.5%, is also expected to underpin growth.
Despite the potential recession, some analysts see this as an opportunity for the Federal Reserve to step in and continue to raise interest rates to curb inflation. Others believe that the central bank should focus on stimulating the economy and supporting consumers.
The current state of the U.S. economy is a delicate balance between slowing growth, high inflation, and a strong job market. It remains to be seen how policymakers will address these issues and what impact they will have on the economy as a whole.