Evelyn Reynolds

Gross domestic product, a broad measure of goods and services produced in the January-through-March period, increased at a 1.6% annualized pace, below the 2.4% estimate.
The personal consumption expenditures price index, a key inflation variable for the Federal Reserve, rose at a 3.4% annualized pace for the quarter, its biggest gain in a year.
Consumer spending increased 2.5% in the period, down from a 3.3% gain in the fourth quarter and below the 3% Wall Street estimate.

U.S. economic growth was much weaker than expected to start the year and prices rose at a faster pace, the Commerce Department reported Thursday.
Gross domestic product, a broad measure of goods and services produced in the January-through-March period, increased at a 1.6% annualized pace when adjusted for seasonality and inflation, according to the department’s Bureau of Economic Analysis.

Economists surveyed by Dow Jones had been looking for an increase of 2.4% following a 3.4% gain in the fourth quarter of 2023 and 4.9% in the previous period.
Consumer spending increased 2.5% in the period, down from a 3.3% gain in the fourth quarter and below the 3% Wall Street estimate. Fixed investment and government spending at the state and local level helped keep GDP positive on the quarter, while a decline in private inventory investment and an increase in imports subtracted. Net exports subtracted 0.86 percentage point from the growth rate while consumer spending contributed 1.68 percentage points.

There was some bad news on the inflation front as well.
The personal consumption expenditures price index, a key inflation variable for the Federal Reserve, rose at a 3.4% annualized pace for the quarter, its biggest gain in a year and up from 1.8% in Q4. Excluding food and energy, core PCE prices rose at a 3.7% rate, both well above the Fed’s 2% target. Central bank officials tend to focus on core inflation as a better indicator of long-term trends.
The price index for GDP, sometimes called the “chain-weighted” level, increased at a 3.1% rate, compared to the Dow Jones estimate for a 3% increase.

Markets slumped following the news, with futures tied to the Dow Jones Industrial Average off more than 400 points. Treasury yields moved higher, with the benchmark 10-year note most recently at 4.69%.
“”This was a worst of both worlds report – slower than expected growth, higher than expected inflation,” said David Donabedian, chief investment officer of CIBC Private Wealth US. “We are not far from all rate cuts being backed out of investor expectations. It forces [Fed Chair Jerome] Powell into a hawkish tone for next week’s [Federal Open Market Committee] meeting.”
The report comes with markets on edge about the state of monetary policy and when the Federal Reserve will start cutting its benchmark interest rate. The federal funds rate, which sets what banks charge each other for overnight lending, is in a targeted range between 5.25%-5.5%, the highest in some 23 years though the central bank has not hiked since July 2023.
Investors have had to adjust their view of when the Fed will start easing as inflation has remained elevated. The view as expressed through futures trading is that rate reductions will begin in September, with the Fed likely to cut just one or two times this year. Futures pricing also shifted after the GDP release, with traders now pointing to just one cut in 2024, according to CME Group calculations.
“The economy will likely decelerate further in the following quarters as consumers are likely near the end of their spending splurge,” said Jeffrey Roach, chief economist at LPL Financial. “Savings rates are falling as sticky inflation puts greater pressure on the consumer. We should expect inflation will ease throughout this year as aggregate demand slows, although the path to the Fed’s 2% target still looks a long ways off.”
Consumers generally have kept up with inflation since it began spiking, though rising inflation has eaten into pay increases. The personal savings rate decelerated in the first quarter to 3.6% from 4% in Q4. Income adjusted for taxes and inflation rose 1.1% for the period, down from 2%.
Spending patterns also shifted in the quarter. Spending on goods declined 0.4%, in large part to a 1.2% slide in bigger-ticket purchases for long-lasting items classified as durable goods. Services spending increased 4%, its highest quarterly level since Q3 of 2021.
A buoyant labor market has helped underpin the economy. The Labor Department reported Thursday that initial jobless claims totaled 207,000 for the week of April 20, down 5,000 and below the 215,000 estimate.
In a possible positive sign for the housing market, residential investment surged 13.9%, its largest increase since the fourth quarter of 2020.
Thursday’s release was the first of three tabulations the BEA does for GDP. First-quarter readings can be subject to substantial revisions — in 2023, the initial Q1 reading was an increase of just 1.1% that ultimately was taken up to 2.2%. More

It’s a tough case to make that higher interest rates are having a substantially negative impact on the economy.
There are big questions over when exactly monetary policy easing will come, and what the central bank’s position to remain on hold will do to both financial markets and economic performance.
There is little precedent for the Fed to cut rates in robust growth periods such as the present, except for the early 1980s, when the central bank stamped out runaway inflation.
That leaves expectations for Fed policy tilting toward cutting rates somewhat but not going back to the near-zero rates that prevailed in the years after the financial crisis.

US Federal Reserve Board Chairman Jerome Powell arrives to testify at a House Financial Services Committee hearing on the “Federal Reserve’s Semi-Annual Monetary Policy Report,” on Capitol Hill in Washington, DC, March 6, 2024. 
Mandel Ngan | Afp | Getty Images

With the economy humming along and the stock market, despite some recent twists and turns, hanging in there pretty well, it’s a tough case to sell that higher interest rates are having a substantially negative impact on the economy.
So what if policymakers just decide to keep rates where they are for even longer, and go through all of 2024 without cutting?

It’s a question that, despite the current conditions, makes Wall Street shudder and Main Street queasy as well.
“When rates start climbing higher, there has to be an adjustment,” said Quincy Krosby, chief global strategist at LPL Financial. “The calculus has changed. So the question is, are we going to have issues if rates remain higher for longer?”
The higher-for-longer stance was not what investors were expecting at the beginning of 2024, but it’s what they have to deal with now as inflation has proven stickier than expected, hovering around 3% compared with the Federal Reserve’s 2% target.
Recent statements by Fed Chair Jerome Powell and other policymakers have cemented the notion that rate cuts aren’t coming in the next several months. In fact, there even has been talk about the potential for an additional hike or two ahead if inflation doesn’t ease further.

That leaves big questions over when exactly monetary policy easing will come, and what the central bank’s position to remain on hold will do to both financial markets and the broader economy.

Krosby said some of those answers will come soon as the current earnings season heats up. Corporate officers will provide key details beyond sales and profits, including the impact that interest rates are having on profit margins and consumer behavior.
“If there’s any sense that companies have to start cutting back costs and that leads to labor market trouble, this is the path of a potential problem with rates this high,” Krosby said.
But financial markets, despite a recent 5.5% sell-off for the S&P 500, have largely held up amid the higher-rate landscape. The broad market, large-cap index is still up 6.3% year to date in the face of a Fed on hold, and 23% above the late October 2023 low.

Higher rates can be a good sign

History tells differing stories about the consequences of a hawkish Fed, both for markets and the economy.
Higher rates are generally a good thing so long as they’re associated with growth. The last period when that wasn’t true was when then-Fed Chair Paul Volcker strangled inflation with aggressive hikes that ultimately and purposely tipped the economy into recession.
There is little precedent for the Fed to cut rates in robust growth periods such as the present, with gross domestic product expected to accelerate at a 2.4% annualized pace in the first quarter of 2024, which would mark the seventh consecutive quarter of growth better than 2%. Preliminary first-quarter GDP numbers are due to be reported Thursday.

For the past several decades, higher rates have not been linked to recessions.
On the contrary, Fed chairs have often been faulted for keeping rates too low for too long, leading to the dot-com bubble and subprime market implosions that triggered two of the three recessions this century. In the other one, the Fed’s benchmark funds rate was at just 1% when the Covid-induced downturn occurred.
In fact, there are arguments that too much is made of Fed policy and its broader impact on the $27.4 trillion U.S. economy.
“I don’t think that active monetary policy really moves the economy nearly as much as the Federal Reserve thinks it does,” said David Kelly, chief global strategist at J.P. Morgan Asset Management.
Kelly points out that the Fed, in the 11-year run between the financial crisis and the Covid pandemic, tried to bring inflation up to 2% using monetary policy and mostly failed. Over the past year, the pullback in the inflation rate has coincided with tighter monetary policy, but Kelly doubts the Fed had much to do with it.

Other economists have made a similar case, namely that the main issue that monetary policy influences — demand — has remained robust, while the supply issue that largely operates outside the reach of interest rates has been the principle driver behind decelerating inflation.
Where rates do matter, Kelly said, is in financial markets, which in turn can affect economic conditions.
“Rates too high or too low distort financial markets. That ultimately undermines the productive capacity of the economy in the long run and can lead to bubbles, which destabilizes the economy,” he said.
“It’s not that I think they’ve set rates at the wrong level for the economy,” he added. “I do think the rates are too high for financial markets, and they ought to try to get back to normal levels — not low levels, normal levels — and keep them there.”

Higher-for-longer the likely path

As a matter of policy, Kelly said that would translate into three quarter-percentage point rate cuts this year and next, taking the fed funds rate down to a range of 3.75%-4%. That’s about in line with the 3.9% rate at the end of 2025 that Federal Open Market Committee members penciled in last month as part of their “dot-plot” projections.
Futures market pricing implies a fed funds rate of 4.32% by December 2025, indicating a higher rate trajectory.
While Kelly is advocating for “a gradual normalization of policy,” he does think the economy and markets can withstand a permanently higher level of rates.
In fact, he expects the Fed’s current projection of a “neutral” rate at 2.6% is unrealistic, an idea that is gaining traction on Wall Street. Goldman Sachs, for instance, recently has opined that the neutral rate — neither stimulative nor restrictive — could be as high as 3.5%. Cleveland Fed President Loretta Mester also recently said it’s possible that the long-run neutral rate is higher.
That leaves expectations for Fed policy tilting toward cutting rates somewhat but not going back to the near-zero rates that prevailed in the years after the financial crisis.
In fact, over the long run, the fed funds rate going back to 1954 has averaged 4.6%, even given the extended seven-year run of near-zero rates after the 2008 crisis until 2015.

Government spending issues

One thing that has changed dramatically, though, over the decades has been the state of public finances.
The $34.6 trillion national debt has exploded since Covid hit in March 2020, rising by nearly 50%. The federal government is on track to run a $2 trillion budget deficit in fiscal 2024, with net interest payments thanks to those higher interest rates on pace to surpass $800 billion.
The deficit as a share of GDP in 2023 was 6.2%; by comparison, the European Union allows its members only 3%.

The fiscal largesse has juiced the economy enough to make the Fed’s higher rates less noticeable, a condition that could change in the days ahead if benchmark rates hold high, said Troy Ludtka, senior U.S. economist at SMBC Nikko Securities America.
“One of the reasons why we haven’t noticed this monetary tightening is simply a reflection of the fact that the U.S. government is running its most irresponsible fiscal policy in a generation,” Ludtka said. “We’re running massive deficits into a full-employment economy, and that’s really keeping things afloat.”
However, the higher rates have begun to take their toll on consumers, even if sales remain solid.
Credit card delinquency rates climbed to 3.1% at the end of 2023, the highest level in 12 years, according to Fed data. Ludtka said the higher rates are likely to result in a “retrenchment” for consumers and ultimately a “cliff effect” where the Fed ultimately will have to concede and lower rates.
“So, I don’t think they should be cutting anytime in the immediate future. But at some point that’s going to have to happen, because these interest rates are simply crushing particularly low-income-earning Americans,” he said. “That is a big portion of the population.”

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