U.S. Economy Slows as Inflation Revisions Point to Potential Rate Cuts

The U.S. economy grew at a slower pace in Q1 2023, with GDP increasing by just 1.3%. Revisions to consumer and equipment spending, along with a lower inflation measure, suggest the Federal Reserve may consider cutting interest rates. Job market strength and widened trade deficits further impact economic forecasts.

The U.S. economy grew more slowly in the first quarter than previously estimated after downward revisions to consumer and equipment spending and a key measure of inflation ticked down, keeping the Federal Reserve on track to possibly begin cutting interest rates before the end of the year. Gross domestic product - the broadest measure of economic activity - grew at an 1.3% annualized rate from January through March, the Commerce Department reported on Thursday, down from the advance estimate of 1.6% and notably slower than the 3.4% pace in the final three months of 2023.

The downgrade of first-quarter growth followed recent softness in other readings of retail sales and equipment spending. Details of the report showed that consumer spending growth, revised down by 0.5 percentage point to a 2.0% annualized rate, mostly reflected a larger-than-earlier-reported drop in household spending on goods. Outlays for big ticket durable goods like motor vehicles and parts dragged on growth by the most since the third quarter of 2021. That drag outpaced upward revisions in the report to business and residential investment.

A measure of inflation during the first quarter was also revised down to 3.3% from 3.4%, the stiffest quarterly price-pressure growth in a year. After easing through much of last year, measures of inflation came in higher than expected to start 2024, driving Fed policymakers to push back expectations for when they'll be able to pivot to interest rate cuts. U.S. Treasury yields ticked lower after the modest downward revision to inflation in the first quarter, and equity index futures pared losses ahead of the opening bell on Wall Street.

A separate report showed the goods deficit in April, the gap between exports and imports, widened to the highest level since May 2022, as strong domestic demand for imports was not matched by export trade. "Prices and consumption were both light in the GDP report. Jobless claims were also higher than expected and the trade deficit was wider. These numbers all point to slower growth and slower inflation. It keeps hopes of a rate cut alive," said David Russell, global head of market strategy at TradeStation.

Investors in contracts tied to the Fed's policy rate slightly added to just about even odds that the central bank could begin to cut rates in September. The downward revision to GDP brings the first-quarter's growth rate to the lowest since the second quarter of 2022, when the economy contracted, and leaves output below the 1.8% rate that officials at the Fed see as its longer-run, noninflationary potential.

The soft start to the year is not expected to have persisted into the current second quarter, however, thanks in part to continued strength in the job market. JOBLESS CLAIMS HIGHER, STILL LOW

That robustness was evident in the number of Americans filing new claims for unemployment benefits last week. While jobless claims ticked higher, the underlying strength in the labor market still shows signs of persisting and should continue to support the economy. Initial claims for state unemployment benefits rose 3,000 to a seasonally adjusted 219,000 for the week ended May 25, the Labor Department said on Thursday. Economists polled by Reuters had forecast 218,000 claims.

The so-called continuing claims tracking those who collect benefits beyond the first week rose 4,000 to a seasonally adjusted 1.791 million during the week ending May 18, the claims report showed. The labor market is steadily rebalancing in the wake of 525 basis points worth of interest rate hikes from the Fed since March 2022 to slow demand in the overall economy. The level of layoffs remains muted overall, however, with the cooling more of a result of less hiring. (Reporting By Dan Burns and Lindsay Dunsmuir; Editing by Chizu Nomiyama)

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