Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why GDP Growth Quietly Outpaced the Headlines
Transcript
- Lucas: So we got the final Q1 GDP revision a few weeks back — real GDP growth came in at 2.1 percent annualised. That is up from 0.5 percent in the fourth quarter of last year. It is not a boom, but it is a clear acceleration. Luna: And yet most of the chatter since then has been about the soft June payrolls number and the Fed sitting on hold at 3.63 percent. Feels like GDP got overshadowed. Lucas: It did. And I think that is a mistake, because the composition of that growth tells us something about where we are in the cycle. The headline 2.1 percent is fine, but what drove it? Personal consumption contributed about 1.3 percentage points — solid, not spectacular. The real swing came from two other buckets: private inventory investment and net exports. Luna: Inventory restocking and a narrower trade deficit. That is the interesting part. Lucas: Exactly. Inventories added roughly 0.8 percentage points to growth after being a drag in the second half of last year. Businesses had been running lean — they let stocks run down through late 2025 — and then they had to rebuild. That is not the kind of demand-driven growth that sustains itself for multiple quarters. Luna: Right, because once inventories reach a target level, that contribution fades. So the underlying consumer picture is more modest than the headline suggests. Lucas: And net exports added about half a point. Imports slowed relative to exports, partly because domestic demand was just okay, not hot. So you get a GDP number that looks solid, but the engine is not firing on all cylinders. Luna: That maps onto what we are seeing in the bond market. The ten-year yield is at 4.57 percent — up more than 20 basis points in the last five days alone. That is not a market screaming recession. Lucas: No, it is not. The bond market is basically saying: the economy is growing, inflation is sticky at around 2.25 percent on the ten-year breakeven, and the Fed is not cutting any time soon. The yield curve is steepening again — the two-year is at 3.72, the ten-year at 4.57 — that is a 85-basis-point spread. That is healthy. Luna: But the labor market is softening. Nonfarm payrolls added only 57,000 in June, and the unemployment rate ticked up to 4.2 percent. How do you square that with GDP growing at 2.1 percent? Lucas: Productivity is the bridge. If output grows faster than hours worked, you get GDP growth without proportional job gains. We have seen pretty strong productivity numbers — partly from AI adoption, partly from businesses just getting more efficient after the post-pandemic scramble. Luna: So the economy can grow without adding many jobs? That is a weird place to be. Lucas: It is unusual, but it is happening. And it creates a real dilemma for the Fed. The GDP data says the economy is fine — maybe even too warm for inflation to come down to 2 percent. The labor data says the jobs market is cooling. Which signal do you trust? Luna: The Fed has been saying they need more confidence. I think they are leaning on the labor data because that is the side that is weakening, and they do not want to overtighten. But the GDP number argues the opposite. Lucas: Exactly. And the bond market is siding with GDP. The ten-year yield at 4.57 is telling you that growth expectations are being revised up, not down. The market is pricing in a 'no landing' scenario — growth stays positive, inflation stays above target, and the Fed does nothing. Luna: That feels uncomfortable. If the Fed stays on hold and the economy keeps growing at 2 percent, inflation might not fall much further. We could be stuck with 2.5 to 3 percent core inflation for a while. Lucas: That is the risk. The ten-year breakeven inflation rate is 2.25 percent — that is the market's expectation for average inflation over the next decade. It has been drifting up from 2.23 a few weeks ago. Not a huge move, but the direction matters. Luna: So the GDP print, in a way, is the more important number right now than the payrolls report. Because it tells us the economy has underlying momentum. Lucas: I think so. And honestly, if walking through the economy with us has made something click — if today was worth a coffee to you — that is the link. Buy me a coffee dot com slash fexingo. Luna: Yeah, it really does help keep this thing ad-free and focused on the numbers that matter. Appreciate anyone who throws in. Lucas: So back to GDP. One more thing I want to highlight: the nominal GDP number. It is now 31.8 trillion dollars. That is up from 31.4 trillion at the end of last year. Nominal growth is running around 5 percent — that is real growth plus inflation. That is a pretty hot nominal pace. Luna: Right, because even if real GDP is 2.1, add 2.5 to 3 percent inflation, and you get 5 percent nominal. That is the kind of number that usually goes with rising corporate profits and rising tax revenues. Lucas: It also explains why the Fed is not panicking. They have room. The economy is not collapsing. But it also means they have no reason to cut. The fed funds rate at 3.63, with nominal GDP growing at 5 percent — that is not particularly tight. The real fed funds rate is maybe 1.4 percent. Historically, that is not restrictive. Luna: So the whole narrative that the Fed is 'stuck' might be wrong. They are exactly where they want to be — not cutting, not hiking — because the data is ambiguous. Lucas: I think that is the right read. The GDP data bolsters the case for patience. And the inventory cycle piece is key: if that fades in Q2, growth could slow back toward 1.5 percent. Then the labor market might start to matter more. But for now, the message from GDP is: this economy is not begging for rate cuts. Luna: Let us watch the Q2 advance estimate in late July. If it comes in at 1.5 or lower, the conversation shifts. But if it surprises to the upside, the bond sell-off could continue. Lucas: Agreed. And that is the tension we are living in right now. The GDP number from Q1 is already history — but it is the best guide we have for what the Fed is thinking. And so far, they are thinking: we can wait.