Fear grips markets as US GDP data points to stagflation

Lorenzo Bagnato

26 April 2024 - 10:32

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After the disappointing GDP quarterly data, markets now fear the worst for the US economy.

Fear grips markets as US GDP data points to stagflation

Greed turned into fear for the US markets as the first-quarter GDP growth yielded a disappointing result. The report also reignited fears of stagflation, considered the worst macroeconomic outcome for any advanced economy.

Gross Domestic Product in the United States grew by 1.6% in the January-March period, below the 2.5% expected. The result was also much worse than the previous quarter when the economy expanded by 3.4%. In the quarter before that, between July and September 2023, the US economy grew by 4.9%.

The decline in economic expansion is a direct effect of the Federal Reserve tightening policy. The Fed raised interest rates to 5.5% in a 13-month cycle.

For months the Fed showed contempt for the stubbornly good economic performance, which was preventing inflation from slowing down. The job market was also a thorn in the Fed’s side, with unemployment reaching all-time lows across the country.

"As we enter the spring, the underlying growth mix continues to signal robust momentum,” EY chief economist Gregory Daco said, “but demand growth is gently cooling leading to easing inflationary pressures.”

The data shows that a steep decline in trading activity contributed to GDP slowing down. Some economists, however, believe imports and exports will accelerate this quarter, rebounding GDP back up.

Stagflation fears

The latest GDP reading came after very disappointing inflation data. The US Consumer Price Index (CPI), the Fed’s favorite inflation indicator, rose more than expected in March to 3.5%.

The Federal Reserve reiterated that it will not consider lowering interest rates until inflation reaches a stable 2%. Markets now believe the Federal Reserve will cut rates only once by December 2024. At the beginning of the year, US markets expected three cuts.

Inflation is rising again mostly because of global geopolitical uncertainty. With Israel-Iran tensions reaching their highest point in history, analysts worry oil prices could reach unprecedented levels. This would reignite inflation in most Western nations, including the United States.

Economists refer to a situation when GDP is decreasing while inflation is increasing as "stagflation". Central banks are usually well-equipped to fight either stagnation or inflation, changing their monetary policy accordingly. Fighting both at the same time, however, could be a significant and lengthy challenge.

Stagflation could have far-reaching repercussions, especially during an election year. So far, the US economy remained on solid feet during President Biden’s term. A last-minute change, however, could hamper his reelection chances, handing the presidency to Republican candidate Donald Trump.

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