Growth Soft Patch to Self-Correct

Summary

• Growth is slowing, mainly due to a consumption slowdown.
• Slower consumption largely reflects a catchup on postponed tax payments in FY2023.
• The slowdown is likely to self-correct as tax payments normalize and businesses’ economic outlook remains sanguine.

Market Implications

• I still expect no 2024 Fed cut, against the market pricing two by end-year. We like to trade this as a tactical short Jan 2025 Fed funds.

Growth Is Slowing

In this note, I argue the US economy is experiencing a soft patch that will self-correct.

Growth is slowing (Chart 1). Q12024 GDP growth, excluding the volatile inventories changes and net exports categories (these are final sales to domestic purchasers), has been revised down to 2.4% QoQ SAAR. This was from an initial estimate of 5.9% and compares with 3.4% in Q42023.

Consumption (accounting for about 70% of US GDP) has driven the downward revisions. Q1 consumption growth has been revised down to 1.5% QoQ SAAR from an initial estimate of 2.5% and compared with 3.3% in Q4 2023.

GDP remained low through Q2, largely due to continued slower consumption growth. The Atlanta Fed nowcast and higher-frequency consumption data show this (Chart 2).

Growth Slowdown Reflects Household Income

Households’ (HH) savings rate and income drive consumption. While the savings rate has been stable, after-tax household income has been slowing (Chart 3). In turn, the slowdown reflects faster growth in personal taxes as before-tax income growth has been accelerating.

The acceleration in tax payments growth in turn largely reflects extreme weather-related tax relief for FY2023 (ending in September 2023). About 30% of US taxpayers were granted six months or more filing extensions. As a result, FY2023 personal income tax receipts were $400bn below FY2022 (Chart 4). With tax filings returning to a normal schedule, personal income tax payments have been catching up.

In that sense, the weaker consumption registered this year is partial payback for the strong consumption registered in 2023, with the latter reflecting tax deferrals (Chart 5). If so, the current weaknesses could persist into Q32024 but eventually self-correct.

Business Demand for Goods and Services Remains Strong

I do not expect slower consumption growth to trigger a negative feedback loop between business demand for labour, household income and eventually demand for businesses’ goods and services. This is largely because the consumption slowdown is limited. Employment income drives pre-tax household income growth, which is accelerating (Chart 6).

Also, businesses on average are keeping a sanguine economic outlook. An acceleration in imported capital goods, a proxy for equipment capex, shows this (Chart 7). In February, I noted how construction capex, spurred by administration subsidies, was soaring but equipment capex was flat. I expected equipment to eventually catch up on structures as businesses would eventually need to fill the capacities they were building.

The ongoing capital goods import surge suggests the equipment catchup is finally happening. This augurs well for labour demand, income, consumption, and eventually growth.

Market Consequences

That said, headline numbers show growth has slowed, unemployment is rising, and disinflation seems to have resumed. On the margin, this lowers my conviction for no cut in 2024 as it raises the case for a 2024 insurance cut.

Yet at this week’s Humphrey Hawkins testimony to Congress, Fed Chair Jerome Powell kept his cards close to his chest. He stated the next Fed move was unlikely to be a hike but also refused to provide guidance on when a cut might occur.

This likely reflects Powell looking closely at the data and not yet seeing a case for an insurance cut (see weekly webinar slides). Also, risks of a Donald Trump election victory and associated positive inflation shock next year have increased. This is why I still expect no cut in 2024, against the market pricing two by December.

We like to trade this view as a tactical short Jan 25 Fed funds.

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Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)