US First-Quarter GDP, Core Inflation Revised Higher

The U.S. economy expanded slightly faster in the first quarter than previously projected, the Bureau of Economic Analysis (BEA) reported.

According to the second estimate published on May 25, the gross domestic product (GDP) climbed at an annualized rate of 1.3 percent in the first three months of 2023, up from the advance estimate of 1.1 percent. However, this is still down from the 2.6 percent expansion in the fourth quarter and below economists’ expectations.

Personal consumption contributed 2.5 percent to the GDP reading, up from 2.48 percent in the original estimate. Change in private inventories added 0.58 percent to the bottom line, up from 0.54 percent. Government spending chipped in 0.89 percent, up from 0.81 percent. Fixed investment erased 0.03 percent, up from negative 0.07 percent. Net exports added just 0.01 percent, down from 0.11 percent.

Despite the slight uptick in economic expansion, market observers paid closer attention to the upward revision in inflation, mainly for its potential impact on the June Federal Open Market Committee (FOMC) policy meeting.

The personal consumption expenditure (PCE) price index was unchanged at 4.2 percent in the latest estimate, up from 3.7 percent in the fourth quarter. However, the core PCE, which excludes the volatile energy and food components, was adjusted higher to 5 percent, up from 4.9 in the first estimate last month. Core PCE prices were also up from 4.4 percent in the October-to-December period.

In addition, the GDP Price Index—a gauge of prices of goods and services manufactured in the United States and exported to foreign markets—advanced to 4.2 percent in the second estimate, up from the first forecast of 4 percent. This was also higher than the 3.9 percent print in the fourth quarter.

Real disposable personal income (inflation-adjusted) was adjusted lower by 0.2 percentage points to 7.8 percent.

The personal savings rate was 4.2 percent in the first quarter, down 0.6 percentage points from the initial estimate.

Due to the higher core PCE print, the futures market is now pricing in a quarter-point rate hike to the benchmark fed funds rate at next month’s FOMC meeting, according to the CME FedWatch Tool.

The latest U.S. GDP numbers come after Germany, Europe’s largest economy, slipped into a recession after posting back-to-back negative quarterly growth rates, the Federal Statistical Office (FSO) confirmed in its second estimate.

“It took a couple of statistical revisions, but at the end of the day, the German economy actually did this winter what we had feared already since last summer: it fell into a technical recession,” said ING economists in a note.

Looking Ahead to the Second Quarter

The Atlanta Fed Bank’s widely watched GDPNow model estimate suggests the U.S. economy will expand 2.9 percent in the second quarter. However, the Philadelphia Fed Bank’s Survey of Professional Forecasters shows the real GDP growth rate will come in at 1 percent, unchanged from the previous forecast.

Early second-quarter data show an economic landscape holding steady.

Retail sales rebounded 0.4 percent in April, up from the 0.7 percent decline in March. But this was below the market estimate of 0.8 percent.

The Chicago Fed National Activity Index, a measurement of overall economic activity and inflationary pressures, turned positive for the first time since January and only the second time since September 2022, rising 0.07 percent.

The U.S. services sector remains strong, with the S&P Global Services Purchasing Managers’ Index (PMI) advancing to 55.1 in May, up from 53.6.

But the national manufacturing sector continues to struggle. This month, the S&P Global Manufacturing PMI returned to contraction territory again, sliding to 48.5, down from 50.2. Moreover, regional central bank data, from the Richmond Fed Manufacturing Index to the Philadelphia Fed Manufacturing Index, confirm that the industry is failing to grow.

“The U.S. economic expansion gathered further momentum in May, but an increasing dichotomy is evident,” stated Chris Williamson, the chief business economist at S&P Global Market Intelligence, in a report. “While service sector companies are enjoying a surge in post-pandemic demand, especially for travel and leisure, manufacturers are struggling with overfilled warehouses and a dearth of new orders as spending is diverted from goods to services.”

Business and consumer sentiment has significantly weakened over the past month.

The University of Michigan’s Consumer Sentiment Index weakened to 57.7 this month, down from 63.5 in April. Likewise, the National Federation of Independent Business (NFIB) Optimism Index dipped to a lower-than-expected 89.0 in April.

The Conference Board’s (CB) Leading Economic Index (LEI), a top recession indicator, fell 0.6 percent in April, lifting its six-month average to 4.4 percent.

“The LEI for the U.S. declined for the thirteenth consecutive month in April, signaling a worsening economic outlook,” Justyna Zabinska-La Monica, the CB Senior Manager of Business Cycle Indicators, said in a statement. “Importantly, the LEI continues to warn of an economic downturn this year. The Conference Board forecasts a contraction of economic activity starting in Q2 leading to a mild recession by mid-2023.”

Arthur Laffer Jr., the president of Laffer Tengler Investments, believes the economy is “chugging along like the little train that could.”

“We think, that at this point, the ‘soft landing’ scenario is the most likely scenario, but it wouldn’t be a huge surprise if we see a quarter of negative growth for Q3 or Q4,” he wrote in a note. “After all of the rebound from COVID, any significant slowdown in growth will look bad, and consumers are just coming to grips with the damage that inflation has done to their purchasing power. It’s no wonder that consumer confidence is low.”

According to minutes from the May FOMC meeting, Fed economists are still penciling in a mild recession later this year.

In addition, former Fed Chair Ben Bernanke wrote in an academic paper that an economic downturn would need to be engineered to return inflation to the institution’s 2 percent target.

The third and final GDP estimate will be released on June 29.