Quick Take: Freakish GDP Nowcast Does Not Signal Long-term Slowdown, Yet

Summary

• Yesterday’s swing in the Atlanta Fed Q1 GDP nowcast to -1.5% QoQ SAAR from 2.3% reflects a swing in imports caused by expectations of tariff increases.
• By contrast, the nowcast for final domestic demand growth remained positive, though well below actual Q4 GDP growth. The slowdown likely reflects higher consumer savings caused by concerns over rising inflation, economic policy uncertainty, and deportation risks.
• The administration still has time to correct its policy and messaging, restore consumer confidence and avoid a growth slowdown, which is my base case scenario.

Market Implications

• I still expect the Fed to remain on hold in 2025, against markets pricing about 2.75 cuts, though my conviction is weaker.

Freakish Nowcast Print Reflects Tariff Front Running

Yesterday’s Atlanta Fed Q1 GDP nowcast ‘GDPnow’ printed -1.5% QoQ SAAR, down from 2.3% a few days ago (Chart 1). The nowcast gets updated based on releases of high frequency macro data. The decline reflects mainly the release of the January goods trade balance that showed an extraordinary worsening caused by a surge in imports (Chart 2). The import surge likely was in expectation of the forthcoming tariff hikes.

GDP can be broken down between demand components:

GDP = C+I+G+X-M

with C = consumption, I = investment and X-M = net exports.

As this accounting identity shows, a worsening of the trade deficit detracts from GDP. After the trade balance release, the net exports contribution to the Q1 nowcast fell to -3.7% QoQ SAAR from previously -0.4%. With the administration talking up the risk of further tariffs, the February trade deficit could be comparable to January.

Yet the import surge does not reflect a long-term change of plans on the part of consumers and businesses but rather that they are bringing forward planned imports. Therefore, once tariff expectations stabilize, possibly in Q2, the trade deficit is likely to improve roughly by the equivalent of its Q1 worsening. This will boost Q2 GDP, offset any Q1 GDP contraction, and keep H1 average growth close to trend. (a swing in inventories could partly offset the net exports swing).

That the nowcast contraction reflects net exports rather than domestic demand is visible where the nowcast for final domestic demand (= GDP x inventories and net exports) remained close to long-term trend at 1.8% QoQ SAAR (Chart 1). Still this is a marked slowdown relative to final domestic demand growth of 3.2 % QoQ SAAR in Q4 and it reflects largely a weakening of consumer confidence.

Policy Uncertainty, Immigration Policies Starting to Cut Into Growth

The slowdown in the final domestic demand nowcast reflects weak January retail sales. Yesterday’s poor January personal spending confirmed this (retail sales include only goods and restaurant spending, while personal spending provides a comprehensive measure of consumption).

The slowdown in January consumption also reflects a sharp increase in the savings rate, to 4.6% from 3.5% in December, rather than a decline in income (Chart 3). Real income growth was well above trend at 56bp MoM.

I think the increase in the savings rate is a response to heightened economic policy uncertainty and to risks of deportation of illegal migrants. According to Fed surveys, about 40% of US households do not have cash for an unexpected $400 expenditure increase. Financially stretched households are likely concerned by risk of losing purchasing power brought about by tariff increases and could have cut spending to increase their savings cushion.

Furthermore, anecdotal evidence suggests illegal migrants have been staying home out of fear of deportation, which is showing up in macro data as lower consumption and labour supply. We find out the impact on labour supply with Friday’s NFPs.

This loss of confidence in the outlook can be seen in the recent declines in consumer confidence and increases in inflation expectations (Charts 4 and 5). This decrease in confidence mirrors the recent increase in policy uncertainty (Chart 6).

Market Consequences

Currently, the consumption slowdown largely reflects uncertainty created by the administration policy announcements. Underlying real income growth remains strong, and so are households balance sheets, on average.

Therefore, the administration has time to refocus its economic messaging and plans and restore consumer confidence, which remains my base case scenario.

But a sustained increase in household worries and the savings rate could trigger a negative feedback loop between consumption and business employment and investment, and eventually between household income and consumption.

For now, I maintain my expectations of no Fed cuts in 2025 for four reasons:

1. While it cannot be precisely estimated, risk exists of residual beginning-of-the-year seasonality.
2. I do not expect the administration to inflict an own goal. Rather I expect better messaging and policy initiatives to stabilize households’ real income and expectations.
3. Risk exists that an inflation slowdown may not accompany a growth slowdown. Tariff increases could raise inflation. Also, the administration deportations could shrink the workforce and add to wage pressures.
4. Because inflation expectations are rising and actual inflation has been above target for nearly four years, I expect the Fed to be reactive to an economic slowdown. Though a resumption of disinflation would see the Fed become more proactive.

That said, yesterday’s data weakens my conviction. By contrast, markets are now pricing 2.75 cuts this year, up from 2.5 before yesterday’s releases.

(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.)