US Stagflation Fears on the Rise

​GDP contraction surprises during a time when inflation is running at 40-year highs will inevitably lead to the stagflation conversation particularly with the Fed set to hike interest rates aggressively.  GDP contracted 1.4% annualised in the first quarter versus expectations of a 1% increase.​

This is not a great headline for the US economy, but lets take a closer look as it might not be as bad as the headline numbers suggest. If we look at domestic demand, we see that it is holding up very well, particularly in the face of the Omnicron wave which had an impact on economic momentum. In fact, consumer spending grew 2.7%, while non-residential investment expanded 9.2% and residential investment posted a 2.1% gain.

What Caused the Negative GDP Number?

It was the drop in exports which was a result of weak foreign demand due to Covid restrictions, and a surge in imports that meant net trade subtracted a full 3.2 percentage points from headline GDP growth. With ongoing supply chain disruptions and ​inventories being run down, this has subtracted a further 0.8% while government spending fell in consecutive quarters and subtracted 0.5pp.

Another Fed Hike in May?

With inflation pressures remaining elevated and the labour market looking tight, today's disappointing GDP numbers shouldn't derail the outlook for a 50bp Fed interest rate hike next week.

With all of these ingredients in the economic melting pot, we are likely to hear a lot more chatter about stagflation rearing it's ugly head.