Economic Growth Outlook Dims as GDP Forecasts Drop to 1.8%

Quick Look:

• Reduced Optimism: Forecasters like Goldman Sachs and Atlanta Fed have lowered GDP growth estimates for Q2 due to weak spending momentum.
• Slowing Economic Activity: ISM’s manufacturing PMI dropped to 48.7 in May, signaling contraction for two consecutive months.
• Market Reaction: Stock markets hit record highs despite economic weakness, expecting potential Fed interest rate cuts.

The economic landscape has seen a notable shift in sentiment as forecasters, who once chased higher data projections, are now scaling back their levels of optimism. Recent data points to a deceleration in several metrics, dampening expectations that economic growth could surprisingly accelerate for a second consecutive year.

Diminishing Optimism Among Forecasters

Neil Dutta, head of economic research at Renaissance Macro, reflected the prevailing sentiment in a note to clients, stating it’s challenging to feel optimistic about the economy. Similarly, the economics research team at Goldman Sachs, led by Jan Hatzius, has revised its second-quarter GDP growth estimates down to an annualized rate of 2.7% from a previously optimistic 3.2%. This adjustment, announced on May 24, was due to weak spending momentum observed at the start of the quarter.

Similarly, the Atlanta Fed’s GDPNow tracker, which estimates GDP growth using data inputs throughout the quarter, has adjusted its projections downward. Initially predicting a growth rate above 4% at the beginning of May, the tracker now forecasts a more modest 1.8% growth rate. This downward revision highlights the cooling trend in economic activity, which is increasingly evident across various sectors.

Indicators of Slowing Activity

Recent data from the Institute for Supply Management (ISM) adds to the narrative of a slowing economy. The ISM’s manufacturing PMI, which measures activity in the manufacturing sector, registered a reading of 48.7 in May. This figure, down from 49.2 in the previous month, fell short of economists’ expectations of 49.5, according to Bloomberg data. The PMI’s drop below the 50 mark, indicating contraction for two consecutive months, highlights the manufacturing sector’s challenges.

Thomas Ryan, an economist at Capital Economics North America, emphasised this point in a note to clients, stating that the drop in the ISM manufacturing index contributes to the sense that the economy is losing momentum. This sentiment is further supported by the April jobs report, which showed weaker-than-expected job growth.

Stock Market and the Federal Reserve’s Next Moves

Despite these signs of economic weakness, the stock market has largely taken this news in stride. All three major indexes reached record highs in May, suggesting that investors are interpreting the data differently. The correlation between the Citi Economic Surprise index and the S&P 500 has been trending toward a negative correlation. It is indicating that bad economic news is increasingly being seen as good news for stocks.

For instance, following the weak April jobs report, the S&P 500 rallied by about 1.3%. Bank of America US and Canada equity strategist Ohsung Kwon highlighted that the trajectory of economic growth will be crucial. If economic conditions deteriorate further, the current trend of bad news being good for stocks could reverse. The upcoming May jobs report, expected to show the addition of 185,000 nonfarm payroll jobs and an unemployment rate holding steady at 3.9%, will be a critical test of this narrative.

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