Source: Zhongjin Dim Sum
Author: Xiao Jiewen, Zhang Wenlang
The US real GDP in the first quarter of 2024 was 1.6% month-on-month discounted, falling short of the 2.4% expected by the market, and lower than 3.4% in the fourth quarter of last year. We don't think this GDP report looks that weak because consumer spending and fixed asset investment, which represent domestic demand, are still steady, and low GDP is being dragged down by high imports. However, the increase in imports indicates that demand is not bad. Local supply cannot meet demand, so overseas supply is needed to meet it. This is consistent with the “short supply” characteristics of the US economy since the pandemic. Compared to GDP data, we think what is more critical is that core PCE inflation rebounded beyond expectations in the first quarter. This is the biggest hidden danger in the market. Flexible inflation will raise the threshold for the Federal Reserve to cut interest rates and keep the dollar interest rate high for longer (high for longer). We have reiterated our previous judgment that the Federal Reserve may cut interest rates only once this year, in the fourth quarter.
First, this GDP report doesn't look that weak, because the indicator representing domestic demand — final sales to the domestic private sector — the month-on-month discount rate only declined slightly from 3.3% in the previous quarter to 3.1%, and the performance is still steady (Chart 1, Chart 2). Final sales to the domestic private sector included consumer spending and fixed asset investment (excluding inventory). Consumer spending increased 2.5% month-on-month in the first quarter, down from 3.3% in the previous quarter. Among them, consumer spending on commodities fell month-on-month, while consumption of durable goods, which is more sensitive to interest rates, fell 1.2%. Service consumption was strong, with a 4.0% month-on-month increase, showing an accelerated expansion trend over the past three quarters (Chart 3). We believe that the slowdown in durable goods consumption was partly affected by high consumer credit interest rates. It is also related to extreme weather in January and the pre-effects of last year's four-season vacation consumption. However, we believe there is no need to be overly pessimistic about the consumer outlook. The reason is that the job market is still stable, and the wealth effect can still support consumers.
Chart 1: The year-on-month growth rate of real GDP in the US
Chart 2: An indicator representing domestic demand — the month-on-month discount rate of final sales to the domestic private sector only declined slightly to 3.1% from 3.3% in the previous quarter
Chart 3: US Real GDP Breakdown
In terms of fixed asset investment, real estate investment grew positively for the third consecutive quarter, and the year-on-year growth rate changed from negative to positive. This shows that the worst time for real estate investment is over, and this is consistent with our judgment in our previous report “US Real Estate Sales May Pick Up.” The year-on-year growth rate of equipment investment also changed from negative to positive. Previously, orders for core capital goods also picked up, indicating that the equipment investment cycle is in the early stages of recovery from bottom to recovery. In contrast, construction investment, which performed well last year, declined year on year, indicating that the peak of manufacturing plant construction brought about by the Inflation Reduction Act and the “Chips and Science Act” has passed (see the report “Early Signs of Reindustrialization in the US”). Overall, consumer spending and fixed asset investment combined contributed 2.6 percentage points to GDP growth in the first quarter, down only slightly from 2.8 percentage points in the previous quarter. This indicates that the endogenous momentum of the US economy is still stable.
So what is dragging down GDP growth? One factor is the high increase in imports. The year-on-month decline in imports in the first quarter was 7.2%, the highest since the first quarter of 2022, dragging down GDP growth by nearly 1 percentage point (Chart 4). By segment, durable goods (+14.6%) from industrial materials, non-durable goods without energy (+37.4%), and computers and related components from capital goods (+36.6%) are imported more. We believe that imports of these industrial and investment products and the recovery in fixed asset investment mentioned earlier can confirm each other. This reflects that domestic supply in the US cannot meet demand (that is, supply is in short supply), so there is a need to rely more on overseas supply to meet it.
Chart 4: Significant increase in import growth
Another factor is weak inventory investment. Changes in inventory investment in the first quarter dragged down GDP growth by 0.35 percentage points, indicating that companies' momentum to replenish inventory was still insufficient (Chart 5). One explanation is that in an environment of high interest rates, consumption of durable goods is suppressed, which may cause wholesalers and retailers to lack confidence in replenishing stocks. Manufacturers' inventory investments are also not strong, which is in line with the characteristics of the equipment investment cycle being in the early stages of recovery. The question now is, if the Federal Reserve delays cutting interest rates, or even if it doesn't cut interest rates this year, will US companies make up their reserves? Judging from this GDP report, there is great uncertainty about the prospects for replenishing stocks.
Chart 5: Inventory continues to drag growth
Another focus of this GDP report is that core PCE inflation rebounded markedly in the first quarter. This is the biggest hidden danger in the market. The core PCE index rose markedly from 2.0% in the previous quarter to 3.7%, exceeding market expectations of 3.4% (Chart 6). In terms of items, the commodity price index fell 0.5%, but service prices rebounded to 5.4% from 3.4% in the previous quarter. Among them, non-housing core PCE prices rebounded sharply to 5.1% from 2.6% in the previous quarter (Chart 7). These data show that service inflation is the “main culprit” of the current high inflation, which is consistent with the strong performance of service consumption expenditure mentioned earlier. This also reflects the spread of inflationary pressure from goods to services as consumer demand shifts from goods to services.
Chart 6: Core PCE rebounded sharply year over month...
Chart 7:... mainly due to service inflation
Flexible inflation will raise the threshold for the Fed to cut interest rates. We repeat our previous judgment that the Fed may only cut interest rates once this year, in the fourth quarter. Our previous report “Lowering the Fed's Interest Rate Cut Forecast” indicated that due to the high elasticity of the economy and inflation, the need for the Fed to cut interest rates has declined sharply. Today's inflation data reinforces our view, and we also repeat once again that excessive inflation is still the main contradiction in the current US economy. The Fed's work to fight inflation is still not over. At the end of last year, the Federal Reserve gave guidelines to cut interest rates too early. At present, it is more like a “policy mistake.” Looking ahead, we think the Federal Reserve will maintain monetary tightness until the end of the year, and US interest rates will stay high for longer (high for longer). If continued monetary tightening allows inflation to slow in the second half of the year, the Federal Reserve still has a chance to cut interest rates once in the fourth quarter of this year.
Editor/jayden