June 6, 2023

The US economy slowed sharply from January through March, slowing to just 1.1% year on year as higher interest rates hit the housing market and companies reduced inventories.

Thursday’s estimate from the Commerce Department showed that the country’s gross domestic product — the broadest measure of economic output — weakened after growing 3.2% from July to September and 2.6% from October to November.

But consumer spending, which accounts for about 70% of US economic activity, remained resilient, growing at an annualized rate of 3.7%, the fastest quarterly pace in nearly two years.

The slowdown reflects the impact of the Federal Reserve’s aggressive drive to curb inflation, with nine rate hikes over the past year. The sharp rise in borrowing costs is expected to plunge the economy into recession sometime this year. While inflation has fallen steadily from the four-decade high it reached last year, it remains well above the Fed’s 2% target.

The housing market, which is particularly vulnerable to higher borrowing rates, has been hit hard. And many banks have tightened their lending standards since the bankruptcy of two major US banks last month, making it even more difficult to borrow to buy a house or a car or expand a business.

Many economists say the cumulative impact of the Fed rate hikes is not yet fully felt. Still, central bank policymakers are aiming for a so-called soft landing: enough growth to curb inflation, but not so much as to plunge the world’s largest economy into recession.

A steelworker inspects a 155mm M795 artillery projectile during the manufacturing process at the Scranton Army Ammunition Plant in Scranton, Pa.
US GDP weakened to 1.1% year on year.

There is widespread skepticism that the Fed will succeed. An economic model used by the Conference Board, a business research group, puts the probability of a US recession in the next year at 99%.

The Conference Board’s recession probability gauge had hovered around zero from September 2020, when the economy bounced back from the COVID-19 recession, until March 2022, when the Fed began raising rates to fight inflation.

Consumers, whose spending accounts for about 70% of US economic output, seem to be feeling the chills. Retail sales got off to a strong start in January, helped by warmer-than-expected weather and increased Social Security checks. But in February and again in March, retail sales plummeted.

A crane stands over a housing project in downtown Denver on Sunday, April 23, 2023.
The slowdown reflects the impact of the Federal Reserve’s aggressive drive to curb inflation.

The greatest fears of a financial crisis like the one in 2008 have subsided over the past month. But continued credit cuts, which were cited this month in the Fed’s survey of regional economies, are likely to hamper growth.

Political risks are also increasing. Republicans in Congress are threatening to default the federal government on its debts by refusing to raise the legal limit on what it can borrow if Democrats and President Joe Biden fail to agree on spending cuts and spending cuts. A first-ever federal debt default would shatter the market for US Treasury bonds – the world’s largest – and potentially spark a global financial crisis.

The global backdrop also looks bleaker. The International Monetary Fund lowered its forecast for global economic growth this month, citing rising interest rates around the world, financial uncertainty and chronic inflation. US exporters could suffer as a result.

A 2023 R1T pickup truck is loaded into a cargo hold at a Rivian delivery and service center on Wednesday, February 8, 2023 in Denver.
The country’s gross domestic product weakened after growing 3.2% from July to September and 2.6% from October to November.

Still, the US economy surprised rather. Recession fears increased early last year after GDP contracted for two consecutive quarters. But the economy roared back in the second half of 2022, driven by surprisingly brisk consumer spending.

A strong job market has given Americans the confidence and financial resources to keep shopping: 2021 and 2022 were the two best years ever for job creation. And hiring has remained strong so far this year, although it has slowed from January to February and then to March.

The April jobs report, due to be released by the government on May 5, is expected to show that employers added a decent but even lower total of 185,000 jobs this month, according to a survey of forecasters by FactSet.