The quarterly release of U.S. GDP (Gross Domestic Product) growth is typically a headline datapoint for economists and investors as the reading gives the broadest picture as to how the U.S. economy is performing. These days however, financial markets are largely looking past it, and instead focusing on inflation, which is the key to financial market performance moving forward.
Friday’s first quarter GDP report showed an economy that largely picked up where it left off in 2018. GDP grew at a 3.2% seasonally adjusted annual rate, which follows full year 2018 GDP growth of 3%. Details within the report showed a buildup in inventories and a boost from net exports as the main catalysts for the advance, while tepid consumer and business spending were offsets. Economists expect many of these items to reverse in Q2, which will leave growth closer to the 2%, still a healthy level.
Core inflation, as measured by the price index for personal consumption expenditures, rose at a 1.6% rate in March, well below the Fed’s target for 2% growth. This matters because the Fed, which holds a meeting this Tuesday and Wednesday, has noted that weak inflation is one of the key factors behind the current “pause” in raising rates, after predicting two rate hikes coming into 2019.
Tepid inflation should allow the Fed to maintain this stance; this has been a key driver of the rally in both stock and bond markets this year. Should inflation accelerate, which most market participants are not expecting, we could see a return to the Fed induced volatility that defined the fourth quarter of last year. Until then, let the good times roll.