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Strong Q1 Could Portend a Slower Q2 as the Fed Meets on Monetary Policy

The Federal Open Market Committee (FOMC) members are meeting Tuesday for a two-day session, and what comes of the meeting could provide a hint as to what to expect for the second quarter of 2019, and the rest of the year.

The meeting comes after Friday’s first-quarter gross domestic product surprise, that saw first-quarter GDP grow 3.2 percent, which was modestly lower than the 3.8 percent growth in the middle of 2018, and higher than the 2.2 percent posted in the fourth quarter.

The FOMC is the monetary policymaking arm of the Federal Reserve, which earlier this year put a hold on interest rate hikes. The rationale was based on a wait-and-see approach, which some have since taken as a signal that economic growth was starting to lose some steam—but how much steam seems to be the question.

That’s not to say that a recession is looming on the horizon–it shouldn’t be, since GDP growth has remained fairly steady.

The Fed cuts rates when the economy is slowing to spur spending and borrowing, but raises rates when the pace of economic growth is heating up to cool it down by increasing borrowing costs.

Ryan Sweet, economist at Moody’s Analytics, isn’t anticipating any change in the Fed’s position, noting that “rate cuts occur when there is a noticeable increase in the risks of a recession.” To justify a rate hike, he noted, core inflation would need to run above the Fed’s targeted 2 percent objective. Sweet said certain data points suggest inflation at 1.6 percent, and he expects inflation to gradually move toward 2 percent this year.

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So where does GDP fit in? It measures the value of goods and services produced by a country, and is therefore one of the primary indicators to measure its health. Economists have estimated GDP growth for the U.S. at the 2.3 percent range for 2019.

Friday’s surprise report from the U.S. Bureau of Economic Analysis indicated that GDP grew 3.2 percent in the first quarter. That was unexpected as most economists tracking GDP data were expecting a growth rate of 2.8 percent, which is lower than the real GDP growth rate of 3.2 percent from a year ago. On a sequential basis, the 2.8 percent projected was still modestly higher than the 2.2 percent growth rate for the fourth quarter.

Despite the GDP surprise, there’s no indication that the economy is suddenly heating up. Over time, that could be a problem since it also might give rise to an increase in inflation. In fact, some believe the economy is actually poised to grow at a slower–but relatively steady–pace in the coming months.

Brian Schaitkin, senior economist for The Conference Board, said the “stronger than expected estimate is primarily the result of temporary contributions from inventories, trade and government spending that are unlikely to be sustained during the year.” The pace of private inventory build in the first quarter, he explained, isn’t likely to continue at the same rate given the slowing sales environment. Spending on durable goods has also been weak, according to Schaitkin.

Because of the slowing trend in consumption and non-residential investment growth, Schaitkin said the Conference Board is forecasting the U.S. economy to grow at a 2.5 percent clip in the second quarter, and 2.3 percent in the second half of 2019. A Fed policy of keeping interest rates low could help “support a stagnant housing market and help the currently weak growth environment for durable goods purchases,” economists said.

Corporate profits are also due to come under pressure as companies face higher payroll costs. Tight labor markets cut into margins when companies can’t pass those costs onto consumers, Schaitkin explained.