The first quarter of the year saw the real GDP grow at a rate of 1.6%, which was lower than market expectations of 2.4%. Economists believe that without a drop in the savings rate, the growth would have been even slower, at around 0.5%. Consumption, a major player in GDP growth, increased by 2.5%, which was also below expectations. This slower growth has led to concerns about the state of the economy and has impacted bond yields.
Despite the slower economic growth, bond rates rose due to an increase in the core Personal Consumption Expenditure (PCE) deflator, a key indicator of inflation monitored by the Fed. The core deflator showed an annual rate of 3.7%, higher than the consensus estimate of 3.4%. Most of the inflationary pressures were seen in housing/utilities, financial services, and healthcare, while goods prices actually deflated. This has led to speculation about when the Fed will make its first rate cut, with some predicting it could happen as early as December.
Consumption in recent quarters has been supported by excess savings from government stimulus measures and low savings rates. However, these savings have now been spent, leading to a rise in delinquency rates and a decrease in consumer spending. Retailers are already reporting a resurgence in consumer frugality, with consumers being resistant to price increases. As a result, both inflation and economic growth are expected to soften in the coming months as consumer spending weakens.
The differences between the way inflation is calculated in the US and Europe have been highlighted, with the European method (HICP) resulting in a lower inflation rate. Economist David Rosenberg believes that the US inflation rate is already below the Fed’s 2% target when calculated using the European method. Despite this, the Fed has signaled a commitment to keeping rates higher for longer, which has raised concerns about potential economic issues such as banking failures and a recession.
The manufacturing sector continues to struggle, with the latest Kansas City Fed Survey showing an eighth consecutive contraction. Wall Street earnings reports have also been disappointing, with retailers noting that consumers are tightening their purse strings. This combination of factors could lead to serious economic issues if the Fed continues to keep rates higher for longer. Lowering rates towards their neutral level may become inevitable, with the timing being the key question.
There are concerns about the impact of rising commercial real estate (CRE) defaults on banks, with the recent closure of Republic First Bank of Philadelphia highlighting the potential risks. The value of CRE has been falling rapidly, making loans less secure, and the upcoming corporate refinancing wall could further strain banks. As a result, there is speculation about how many banks may fail as a result of the current economic conditions and the challenges in the CRE sector.
