The Other Shoe Drops

In the last half of April, there were a couple of seminal economic events that, taken together, mark an example of proverbial shoes dropping, and for the first time in years, marks a cautionary signal on the economy.

The first shoe to drop was when Fed Chairman Jay Powell unexpectedly announced that firmer-than-expected inflation during the first quarter has called into question whether the Federal Reserve will be able to lower interest rates this year without signs of an unexpected economic slowdown. His remarks indicated a clear shift in the Fed’s outlook following a third consecutive month of stronger-than-anticipated inflation readings, which derailed hopes the central bank might be able to deliver pre-emptive rate cuts this summer. This has coined a term among the Wall Street community of “higher for longer,” and visibility on a first quart-point rate cut has become very foggy. In fact, one Wall Street poll is now estimating a 19 percent chance that the Fed will hold interest rates steady through year’s end, up from below 1 percent just a month ago.

Within days, the other shoe dropped. In an unexpected surprise, Gross Domestic Product (GDP) growth in the first quarter of 2024 expanded at a 1.6 percent seasonally- and inflation-adjusted annual rate, a pullback from last year’s quick pace. That lagged behind the 2.4 percent projected by economists polled by leading business publications. The Fed’s report also suggested that inflation, using the Fed’s preferred gauge, was likely firmer than expected in March, which gives investors another reason to give up on the idea that the Fed could begin cutting interest rates in the coming months.

Typically, an underwhelming growth figure would boost hopes that the Fed will lower interest rates. But continued price pressures complicated that outlook. The latest snapshot of the U.S. economy rattled stock and bond markets with two bits of potentially disappointing data: slower economic growth and still-firm inflation. Does this portend a slowdown in the economy? I’ll say it again: no.

First, remember the quiet, steady economic times before Covid-19; back then, economic growth was fairly consistent in the low to high 2 percent range, and the steady rate of growth, coupled with low interest rates, kept the economy humming and inflation under control. The pandemic turned the economy on its ear, the multiple forms of economic stimulus started winding its way through the system, creating shortages exacerbated by supply chain issues caused by the lockdown. Of course, stimulus created demand, and inflation skyrocketed.

The Fed report also showed that American consumers are still strong after years of hiring and wage growth. Spending on healthcare, insurance and other services continued to grow, and measures of underlying demand remain robust, leading economists to warn that the market was overreacting to an isolated data point. Many economists pointed out that prices were a little bit over the top, but not by much. It appears the slowdown in spending on goods, such as cars and gasoline, weighed down overall growth, and more importantly, shifts in business inventories and international trade also slowed last quarter’s expansion, but economists cautioned that those figures can vary widely throughout the year. Economists also point out that a decrease in inventories can really be good news for the economy, as it bodes well for a spurt of investment in the next quarter.

As a parting thought, remember what I have been saying all along: the construction economy is insulated from the rest of the general economy right now, and will be for years to come. The Infrastructure Investment and Jobs Act is pouring $1.2 trillion into construction of all types, assuring a robust industry through late in the decade. And it is interesting to note another data point: Housing’s share of the economy rose to 16.1 percent in the first quarter of 2024. This increase to above 16 percent marks the first time housing’s share of GDP reached that watermark since 2022, before interest rates started their march upwards.

The first quarter’s GDP report is just a speed bump in the road. Regardless of what happens to the broader economy, I’m still firm on strength in construction for years to come.

Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers & acquisitions. He has a career spanning almost five decades, and volunteers his time to educating the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at [email protected]. Follow him on Twitter – @allenvillere.