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26 April 2024 | FXGT.com

US Stagflation Scenario Emerges as Economic Growth Slows and Inflation Persists

  • US Economy Facing Stagflation Risk: Yesterday’s U.S. GDP data has introduced further pessimism into the market by indicating a scenario of lower economic growth coupled with higher inflation, often referred to as “stagflation.” This condition is typically unwelcome in financial circles due to the dual pressures of slowing economic activity and rising prices, which can complicate monetary policy responses.
  • Q1 GDP Figures: The U.S. economy showed a slower growth rate in the first quarter, with GDP increasing by 1.6% on a quarter-over-quarter basis. This figure fell short of the anticipated 2.5% and was significantly lower than the 3.4% growth rate observed in Q4 2023. However, inflation metrics embedded within the GDP report indicated increased price pressures, potentially influencing the Federal Reserve’s monetary policy decisions.
  • Inflationary Pressures Continue: Contrasting the GDP’s weaker performance, the PCE price index, a key measure of inflation closely watched by the Federal Reserve, rose to 3.4% from 1.8% in the previous quarter. The core PCE, which excludes volatile food and energy prices, escalated to 3.7%, up from 2.0%, suggesting that underlying inflation fears remain high.
  • Implications for Monetary Policy: These inflation figures highlight persistent inflationary pressures, despite the slowing economy. Initially, the disappointing GDP data might suggest a leaning towards rate cuts to support economic growth. However, the sharp rise in the PCE indices complicates this narrative by highlighting sustained inflation risks, which could deter the Federal Reserve from reducing rates prematurely.
  • Market Reaction: Following the release, the U.S. dollar experienced initial weakness due to the lower GDP figures, indicating concerns about economic momentum. However, it quickly recovered as the market digested the higher-than-expected inflation data, which potentially supports the Fed’s stance on maintaining “higher for longer” interest rates.
  • Anticipation Around Core PCE Data: Investors are now turning their attention to the upcoming core Personal Consumption Expenditure (PCE) Price Index data for March, which is crucial for shaping Fed rate cut expectations. An acceleration in the PCE data may temper expectations for multiple rate cuts, potentially limiting to just one this year. The market currently anticipates the first rate cut to occur in September, pending further economic indicators.
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