US GDP (Q1 2024 — first estimate)

US economy disappoints for the right reasons

• Real GDP growth only advanced 1.6% annualized in Q1 2024, following a strong 3.4% gain in Q4 2023. But while the headline print missed expectations by a mile, most of the shortfall stemmed from stronger than expected imports pulled in by solid final demand growth. In fact, we would argue the 3.1% advance in final demand to private domestic purchasers is a better gauge of the underlying pace of economic activity.
  
  
• Still, this report pours cold water on the misleading narratives of a reaccelerating economy. As we enter the spring, the underlying growth mix continues to signal robust momentum, but demand growth is gently cooling leading to easing inflationary pressures:
  
  
  • Consumer spending grew 2.5% with consumers cutting back on durable goods and visibly satiated on nondurable goods but still spending freely on services and experiences.
    
    
  • Residential investment posted a remarkable 13.9% advance — one of the strongest gains of the last decade — supported by resilient construction activity.
    
    
  • Business investment grew a moderate 2.9% as healthy rebounds in equipment and intellectual property product investment offset a notable slowdown in structures investment.
    
    
  •  Restocking efforts were curbed so that inventories imposed a 0.4 percentage point (ppt) drag on GDP growth.
    
    
  • Net trade was a massive 0.9ppt drag on GDP growth, but this is essentially good news as it reflects the strongest gains in imports in two years driven by goods and services.
    
    
  • Government spending growth slowed to 1.2% — its slowest pace in two years — with federal spending contracting and state and local outlays growing at a reduced pace (+2.0%).
    
    
• On the inflation front, price pressures eased modestly in Q1 with headline inflation cooling 0.2ppt to 2.6% year over year (y/y) — the lowest since Q1 2021 — and core personal consumption expenditures (PCE) inflation softened 0.3ppt to 2.9% y/y — also the lowest since Q1 2021. We foresee headline and core PCE inflation ending the year around 2.5% y/y in Q4.
  
  
• Overall, economic activity remains resilient powered by consumers’ ongoing ability and willingness to spend, even if they are being more scrutinous in the face of high prices. A robust labor market along with positive real wage growth continues to provide a solid foundation to consumer outlays. Meanwhile, businesses are focusing on high return-on-investment projects and productivity-enhancing investments in an elevated cost and interest rate environment.
  
  
• As we move into Q2, we believe the economy will gently cool as slower labor demand, easing wage growth, stubborn inflation and tight credit conditions constrain private sector activity. And we stress that if inflation proves to be stickier than anticipated, the downside risk to the economy from reduced real income growth, a “higher for longer” Fed stance and tightening financial conditions could be notable.
  
  
• Overall, we anticipate real GDP growth will average 2.4% in 2024, constrained by a slower start to the year, and we continue to expect growth will cool to 1.7% in 2025.
  
  
• With the Fed Chair indicating the Fed should allow restrictive policy further time to work, and a clear majority of policymakers favoring two or fewer rate cuts, we expect only two 25 basis points rate cuts in 2024 (down from three previously) in July and November.

In the details:

The 1.6% real GDP advance featured a 2.0% increase in real final sales and a 0.4ppt drag to growth from inventories. Growth in real final sales to domestic purchasers (which excludes the net international trade components) cooled to 2.8% from 3.6% in Q4 2023, while real final sales to private domestic purchasers (also excluding government spending) cooled to 3.1%, from 3.3% in the prior quarter. On a year-over-year basis, real GDP cooled to 3.0% from 3.1% y/y in Q4 2023.

Consumer spending grew 2.5% in Q4 following a robust 3.3% gain in Q4. Spending on services drove the gains, surging 4.0% on broad-based gains including in transportation (+4.6%), recreation (+4.9%), health care (+5.5%) and financial services (+7.9%). The one notable blemish was a 2.0% contraction in spending at restaurants and bars. Outlays on nondurables were flat as a plunge in outlays on gasoline and energy offset robust spending on groceries and clothing. Spending on durables eased 1.2% on a plunge in car sales (likely weather disrupted in January).

Looking ahead, with employment and household income growth gradually softening, prices remaining elevated, and interest rates likely to ease only gradually, we expect households will exercise more scrutiny with their outlays. We foresee consumer spending growth of 2.3% in 2024, supported by solid early-year momentum, following a 2.2% advance in 2023.

Residential investment surged 13.9% — its third consecutive quarterly gain and the third largest in a decade — but remains down 16% from its 2021 Q1 peak. While the worst of the housing sector correction is behind us, we anticipate modest residential investment growth H1 constrained by depressed affordability and moderate income growth. Construction activity is, however, still likely to benefit from a severely undersupplied housing market where vacancy rates are historically low.

Business investment growth cooled to 2.9% in Q1 following a 3.8% advance in Q4 2023. Structures investment fell back 0.1% after recording average growth of 12.7% in the prior three quarters. This could indicate reduced momentum in the segment that surged on the back of strong policy incentives. Equipment investment rebounded 2.1% as a surge in information processing equipment and industrial equipment investment was offset by a pullback in transportation equipment investment. Intellectual property investment grew 5.4% driven by investment in software and R&D.

Elevated interest rates, tighter credit conditions and sluggish global demand are still forcing business leaders to exercise scrutiny with their investments, but stronger global growth and lower interest rates in the coming quarters should support momentum.

Government spending rose a modest 1.2% as federal outlays fell 0.2% — the first contraction in two years. Spending growth at the state and local level is also cooling with a 2.0% following a 6.0% gain in Q4 2024. The slowdown stemmed entirely from gross investment growth cooling from 22.1% in Q4 to 1.6% in Q1 — again another sign that the pass-through from greater policy support is ebbing (CHIPS and Science Act and IRA).

Net international trade subtracted 0.9ppt from GDP growth, as the robust 7.2% growth in imports outpaced the 0.9% advance in exports. Looking into the details, strong imports appear to have been drawn in by solid consumer spending and investment growth along with rebounding tourism activity. Looking ahead, we anticipate cooler imports as domestic activity slows and moderate exports momentum as global activity remains subdued.