Real business fixed investment increased at a rate of 2.9%. This included a 2.1% increase for business equipment (the first increase in three quarters, fueled by investment in information technology and offset by a sharp drop in investment in transportation equipment), a 0.1% decline for structures, and a 5.4% increase for intellectual property (which includes software and R&D). Real investment in residential property was up at a rate of 13.9%. On the other hand, a decline in business inventories reduced real GDP growth by 0.35 percentage points. The rise in investment in information technology was the strongest since the first quarter of 2022. This bodes well for demand for consulting services.
Meanwhile, although real exports of goods and services were up 0.9%, imports were up 7.2%. This means that net exports made a negative contribution to GDP growth. In addition, while state and local government purchases were up at a rate of 2%, real Federal purchases were down 0.2%.
Although real GDP grew more slowly than expected in the first quarter, the core components did very well. Final sales to private domestic purchasers (which excludes the impact of trade, government, and inventories) were up at a rate of 3.1%. This was the second-fastest rate of growth since the fourth quarter of 2021 when the economy was bouncing back from the pandemic downturn. Thus, the news on economic growth remains relatively good. Moreover, the news suggests that the United States remains a prime engine for global economic growth. Still, the weak headline number evidently spooked investors.
- The US government also published data on household income, consumer spending, and the Federal Reserve’s favorite measure of inflation. Although the news on household spending was good, investors mainly focused on the inflation numbers.
Specifically, it was reported that the personal consumption expenditure deflator (PCE-deflator) was up 2.7% in March from a year earlier, up from 2.5% in February. This was the first acceleration in the index since September 2023. However, when volatile food and energy prices are excluded, the core PCE-deflator was up 2.8% in March versus a year earlier, the same as in February. Core inflation has been relatively steady for four months, suggesting that the previous deceleration has halted.
The inflation problem remains one of services, which are labor intensive. Thus, the problem is the tight labor market, which is generating significant wage gains. Specifically, prices of durable goods were down 1.9% from a year earlier while prices of non-durables were up only 1.3%. This included food, which was up just 1.5%. Yet prices of services were up 4% from a year earlier, roughly unchanged over the past five months.
As such, it is not surprising that futures prices are implying a 60% probability that the Fed will start cutting rates in September. Plus, they imply only a 50% chance of a second rate cut in 2024. This is a sea change from just a few months ago when investors expected the Fed to start in June and undertake three to four cuts in 2024. The shift in investor expectations reflects the persistent tightness of the labor market and strong underlying demand in the economy. Investors evidently believe that the Fed will not loosen monetary policy while the economy is so strong and underlying inflation is stuck.
Meanwhile, the US government also reported that, while real disposable personal income was up 0.2% from February to March (the fastest growth since December), real personal consumer spending was up 0.5%, the same as in the previous month. Thus, households continue to reduce savings to enable strong increases in spending. The personal savings rate fell from 3.6% in February to 3.2% in March.
- The Federal Reserve intends to keep interest rates high for longer, largely because the US labor market has remained unusually tight, thereby generating wage gains that propel inflation in services. Thus, any indication that the labor market is loosening would be welcome news for the Fed. The latest data suggested that labor market tightness is easing. The government reported a sharp slowdown in employment growth in April, although it remains higher than the expected long-term trend. Plus, wage growth in April receded. Let’s look at the data.
The US government report on employment includes results from two surveys: one is a survey of households, and the other is a survey of establishments. The establishment survey found that, in April, 175,000 new jobs were created. This was the slowest job growth since October 2023. On the other hand, the growth for March was upwardly revised to 315,000, an unusually strong number. One month does not make a trend. However, if the slower growth seen in April persists in the months to come, it will likely signal an easing of labor market tightness. That, in turn, might influence the decisions of the Federal Reserve.
By industry, there was very modest job growth in goods-producing industries (mining, construction, manufacturing). There was a decline in employment in information as well as professional and business services and there was very modest growth in financial services, leisure and hospitality, and government. Moderately strong growth took place in wholesale trade, retail trade, and transportation. But the strongest growth took place in health care and social assistance. Overall, April was a relatively poor month for job growth.
The establishment survey also includes data on wages. The report says that, in April, average hourly earnings of all workers were up only 3.9% from a year earlier, the smallest increase since March 2021. Thus, wage pressure is evidently easing. However, it remains too high given the Fed’s goal of 2% inflation. If productivity were rising rapidly, then businesses could increase wages without increasing prices as they would be getting more out of each worker. Yet as indicated below, productivity growth stalled in the first quarter.
Finally, the household survey indicated that, in April, employment grew more slowly than the labor force, thereby leading to an increase in the unemployment rate to 3.9%, still a very low level.
- The US government also reported on labor productivity in the first quarter. Recall that, in the three most recent quarters, labor productivity (output per hour worked) increased rapidly. This was helpful in reducing inflation. It also contributed to strong economic growth. The rise in productivity in 2023 was likely related to business investments in labor-saving and labor-augmenting technologies, a response to the tight labor market.
Yet, in the first quarter of 2024, labor productivity nearly stalled. Productivity increased only 0.3% from the fourth quarter of 2023 to the first quarter of 2024. This followed strong growth of 3.5% in the previous quarter. The result was that, with wages continuing to rise, unit labor costs (ULCs) accelerated sharply in the first quarter. ULC denotes the labor cost of producing a unit of output. It is calculated as real (inflation-adjusted) hourly compensation divided by productivity. Thus, if productivity rises at the same rate as real wages, then ULCs are unchanged. That implies that companies needn’t raise prices in line with wage increases.
In the second half of 2023, ULCs were basically unchanged as productivity gains offset real wage gains. Yet in the first quarter, ULC was up 4.7% from the previous quarter. Moreover, ULC was up faster for services than for manufacturing. This is not good news for suppressing inflation, especially given that most of the remaining inflation is the services sector.