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Does the weak GDP report for the first quarter fully reflect the underlying state of the economy?

While GDP growth for the first quarter came in much weaker than expected, the primary drivers of the economy are still growing at a solid clip.

Chart depicting consumption and private investment held firms in Q1

After a prolonged period of stronger than expected growth, initial estimates of Q1 GDP growth came in well below expectations. Combined with persistently elevated inflation, the disappointing Q1 GDP print has prompted an increase in discussions about a “stagflation” scenario (weak growth with high inflation). However, is the recent GDP release really an indication of economic stagnation?

First, while the 1.6% quarterly increase was much softer than expected, it’s still a far cry from economic stagnation, and is in line with most estimates of long-run potential GDP growth. One quarter of muted, but still solidly positive, growth is not an indicator that we’re entering an extended period of economic weakness.

Secondly, the underlying data doesn’t paint as poor of a picture as the headline growth number might suggest. Much of the unexpected weakness in Q1 GDP was driven by a surge in net imports, which slashed nearly 1.0% from top-line growth. In fact, excluding the more volatile pieces of GDP (net exports, inventories, and government spending), core consumption and private investment grew at an annualized pace that topped 3% in the first quarter, virtually unchanged from its 2023 pace.

What does this mean? The recent slowdown in growth doesn’t appear to be a sign of stagnation. Multiple indicators continue to suggest inflation should remain on its downward trajectory, even if the path back to 2% is slower than had been expected. Growth has slowed, but a reduction in demand was exactly what the Fed had in mind when it raised short-term rates, cooling demand to bring inflation back into a palatable range. For now, it appears that the Fed’s plan is working.

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