Source: Wall Street News

The US GDP growth rate for the first quarter fell short of expectations, and the March core PCE price index released on Friday also exceeded expectations, causing the market to worry that the US economy may enter stagflation.

However, Citibank recently released a research report that although core inflation in March did not slow down further, increasing the possibility of interest rate cuts in July rather than June, Citibank still believes that it is wrong for the market to completely phase out interest rate cuts this year. This is because concerns about slowing growth will be a key factor for the Federal Reserve to consider cutting interest rates, and first-quarter GDP details show that support for fiscal stimulus is weakening, and commodity spending is also weak. Therefore, Citi believes that although inflation has not continued to slow, the Federal Reserve will cut interest rates this summer.

Stagflation? Citi: Interest rates will still be cut this summer

According to the data, US GDP grew 1.6% month-on-month in the first quarter, lower than the 2.5% market consensus and 2.0% lower than the consensus forecast by Citi. Among them, consumption increased by 2.5%, spending on goods fell by 0.4%, while the service sector grew by 4.0%; commercial investment increased by 2.9%, while residential investment rose sharply by 13.9%. Overall, private final domestic demand slowed only slightly from the fourth quarter to 3.1%.

Meanwhile, government spending has slowed compared to previous quarters, growing by only 1.2%. Net exports dragged down economic growth by 0.9%, while inventories also dragged down 0.4%.

The US Department of Commerce released data on Friday. The Fed's preferred inflation target and the March core PCE price index after excluding food and energy grew by 2.82% year-on-year, higher than the forecast of 2.7%. The previous revised value was 2.8%. The month-on-month growth rate was 0.3%, in line with expectations, and remained the same as the previous value.

Faced with data showing stagflation trends, Citi believes that this provides an uncomfortable background for Fed officials to consider when to cut interest rates this year. However, given the details of GDP for the first quarter showing strong private domestic demand, the focus now may be more on strong inflation data.

The research report pointed out that core PCE inflation unexpectedly rose sharply in the first quarter, and core PCE inflation also exceeded expectations in March, but it is worth noting that this is in line with the Federal Reserve's forecast.

Citi previously predicted that the Federal Reserve would continue to cut interest rates in June based on PCE core inflation figures of 2.7% in March.

However, as inflation intensified in March, Citi believes that the possibility of cutting interest rates in July has increased compared to June. The research report continues to believe that the market's expectations of completely falling out of interest rate cuts this year are too aggressive, and still believe that the Federal Reserve may start cutting interest rates this summer.

Maintaining growth is the key

The research report points out that in considering these interest rate cuts, one key consideration will be growth concerns, as higher interest rates for a longer period of time will put pressure on demand.

According to the research report, although the details of GDP in the first quarter were more positive than the overall 1.6% increase, there are still signs of slowing domestic demand. Commercial equipment investment is stronger than expected, but shipments are already slowing down. Non-residential investment and government spending also slowed in the first quarter, which is in line with weak data on construction spending, as financial support for construction projects may have peaked. Government spending contributed 0.2% to GDP growth in the first quarter, compared to 0.8% to 1% for almost every quarter over the past five quarters. Furthermore, strong housing investment should weaken as higher interest rates affect housing demand.

Meanwhile, over the past few quarters, strong consumption has been increasingly driven by a few sectors, such as healthcare and financial services. The research report said that inflation in these sectors did not increase in the past, and Citi was surprised by this because it showed that actual spending was too high. If based on just a few sectors, the continued strength in service spending doesn't seem stable. Spending on goods also declined in the first quarter, usually leading to a slowdown in the service sector.

Citi believes that on the face of it, private domestic demand and inflation were strong in the first quarter, and the Federal Reserve will be comfortable keeping interest rates unchanged. Looking ahead, however, due to gaps in economic activity and labor market data, Citi expects that until inflation continues to slow, more obvious signs of weak growth will cause the Federal Reserve to cut interest rates.

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