Firm US data to keep the Fed treading cautiously

Underlying demand still resilient

Q1 GDP growth actually surprised to the downside, at 1.6% q/q annualised vs 2.5% consensus. However, the details showed that the bulk of the surprise was driven by a large negative contribution from net exports (-1pp), driven by a jump in imports of 7.2% annualised. Inventories also subtracted somewhat from GDP, though this was something we had expected. Underlying demand – particularly consumption – remained solid, growing 2.5% annualised, albeit slowing from the >3% growth in Q3-Q4 23. Housing investment rebounded sharply – by 13% annualised – following a prolonged period of weakness on the back of high rates, but fixed business investment (excluding intellectual property) was comparatively weak, growing just 1%. All told, the economy is clearly slowing from the well-above trend rates of growth, but underlying demand remains resilient. In the near-term, we expect some further cooling in consumption, but this is likely to be offset by positive payback from net exports as some of the jump in imports is likely to unwind in Q2. We continue to expect growth to average 2.5% in 2024 (see here for more). Small revision to January was responsible for Q1 core PCE surprise

PCE (both core and headline) inflation data for March were in line with expectations at 0.3% m/m, with the core number a little higher than our expectation, at 0.3% vs 0.2%. Annual headline inflation came in at 2.7% y/y (up from 2.5% in February), with the core PCE holding steady at 2.8%. Markets were roiled yesterday when the Q1 PCE inflation figure came in above expectations at 3.7% vs 3.4% annualised, raising expectations that the March figure would be much firmer. As it happened, the upside surprise was driven by a comparatively small upward revision to the January figure (from 0.45% to 0.50% unrounded). While still not great news for the disinflation narrative, this is important because the most recent months have only been a touch on the firm side rather than well above target-consistent levels (for reference, a 0.2% m/m rise would be consistent with 2% annual inflation). Meanwhile, we continue to see little in the data to suggest the recent firm inflation readings are durable. Wage growth is benign, and data on rents suggest we are overdue a downside surprise in the all-important shelter component. Market moves over the past 24 hours are understandable given the recent history with inflation, but the data can easily turn the other way quickly; just as the data in Q1 have been much higher than in Q4 23, the coming months could also be much more benign than recent figures. Still, the Fed is likely to tread cautiously and will need to see 2-3 consecutive benign inflation readings before it will be ready to lower rates. By the July FOMC meeting – our expectation for the start of rate cuts – the Fed will have had three more inflation reports (April, May, June) to base its decision on. While the recent data flow does raise the risk that rate cuts are further pushed out, markets are likely to be highly sensitive to any shift in the data.