The economy came out of the gate reasonably well to start the year, expanding at a solid 2.5% annualized pace during the first quarter. Nonetheless, that increase fell short of expectations for growth of about 3.0%.
Inflationary pressures continue to ebb. The Personal Consumption Expenditures (PCE) Deflator rose 1.2% for the quarter, its lowest quarterly result since late 2009. Excluding food and energy, the index also rose at a modest 1.3% pace. As one of the Fed’s preferred measures of inflation, this result will surely be seen by the central bank as further ammunition to support their easy money policy.
If there is a bright spot in the report, it’s the story of the American consumer. Personal consumption posted a solid 3.2% advance in spending during the quarter, although it was less noteworthy on a year-over-year basis, rising by just 2.0%.
The rebound in housing in particular also remains a positive story, although the pace of growth took a step back in the first quarter. Whether the slowdown was an anomaly or evidence that the housing recovery may be slowing remains to be seen.
Household finances continue to be constrained by lackluster income growth. Real disposable personal income grew by just 0.9% in the past year. In the absence of more robust income growth, households have largely chosen to trim savings to fuel spending. That strategy helps over the short-term, but is not a long-term solution.
Spending cuts in the government sector were a drag on growth during the quarter at all levels of government. Cuts at the federal level topped 8%, but the budgetary axe was also apparent at the state and local level.
The effects of the sequester are only starting to be implemented and will become magnified in the coming quarters. The cuts in the first quarter were largely unrelated to the sequester; as such, the public sector is poised to further drag on growth in the quarters ahead.
With the outlook for business investment still unclear, exports constrained by weakness outside the U.S., and government spending set to decline, can consumers carry the load to keep the economy moving forward over the next few quarters? That remains an open question.