- The economy expanded at an annual rate of 1.6% in the first quarter.
- The US core PCE price index increased by a bigger-than-expected 3.7%.
- US unemployment claims fell, surprising economists forecasting an increase.
Interest futures fell on Thursday after a poor US GDP report. At the same time, downward pressure came from a rally in Treasury yields amid signs that US inflation remains high. Consequently, investors are keen to see the outcome of the core PCE price index report on Friday.
US GDP, core PCE price index (Source: Bureau of Economic Analysis)
On Thursday, US data showed that the economy grew at an annual rate of 1.6%, lower than the expected 2.4% growth forecast by economists. Although there is little risk that the economy will enter a recession, there was a significant slowdown in Q1. However, investors focused more on the report’s core personal consumption expenditure figures. The core PCE price index increased by a bigger-than-expected 3.7%, raising concerns that Friday’s figures will also be high.
If the GDP report had not shown high inflation, the decline in growth would have come as a welcome surprise for the Fed. Weaker economic growth indicates that higher interest rates are having the intended impact. However, when inflation remains high, the central bank faces a more significant challenge of balancing growth and inflation. Prolonged higher interest rates could further weaken demand in the economy, especially if inflation remains stubborn.
Notably, after the report, the chances of a cut in September fell to 58%. Meanwhile, there was a higher chance of 68% that the Fed would cut in November. Short-term Treasury yields that reflect interest rate expectations soared.
Meanwhile, additional data from the US revealed high demand in the labor and housing sectors. US unemployment claims fell, surprising economists forecasting an increase from the previous week. Demand in the labor market has remained strong despite high borrowing costs. As long as this demand continues, consumers will have enough purchasing power to drive up sales and, eventually, inflation. Consequently, the Fed has remained cautious about rate cuts due to recent upbeat job data.
Meanwhile, pending home sales figures rose more than expected, giving the Fed another reason to delay rate cuts. Recent economic reports from the US have gradually changed the outlook for Fed policy. Policymakers have lost confidence that inflation is falling. At the same time, some experts believe the Fed might not cut rates this year, which is bearish for interest futures.
