The US economy is facing a very uncertain future with inflation up and consumer sentiment at record lows.
Headlines tied to the US economy continue to focus on President Trump’s Middle East actions and the consequences for global energy prices. Abstracting from this news storm, however, the message from available economic data is the US economy slowed below trend ahead of the conflict, leaving the economy at risk of stalling, at least briefly.
In understanding the US’ current state and outlook, it is best to assess recent data chronologically. First estimated at 1.4% annualised, Q4 GDP growth has since been revised to just 0.5%. Underlying the headline revisions, personal consumption growth throttled back from a near-trend 2.4% to a sub-par 1.9%, and business investment from an already-weak 3.7% annualised to 2.4%, as residential investment contracted 1.7% annualised.
Come January and February 2026, personal consumption expenditure was essentially flat and core goods order growth slowed to less than a third of Q4’s pace. We do not have reliable data to back the assertion, but it is hard to believe the recent rise in the US 10-year yield and pass-through to the 30-year mortgage rate won’t put additional pressure on residential construction. The current Atlanta Fed GDPNow estimate of 1.3% annualised therefore seems likely to slip through April before the formal Q1 GDP result is released by the BEA.
Another step down in momentum, perhaps into outright contraction, come Q2 is clearly a risk. The only data to hand for April is the University of Michigan’s consumer sentiment survey. Worryingly, the headline index fell to its weakest read on record at 47.6 – an impressive feat considering the survey dates back to 1978 and has averaged 83.8 since, 43% above April’s read. Notably, both current conditions and expectations are at all-time lows, and this is despite nonfarm payrolls having bounced back in March and equity markets, in aggregate, showing resilience.
While nonfarm payrolls have averaged a gain of 68k the past three months, this follows the average loss of 8k jobs per month through the second half of 2025 and material downward revisions to historical estimates prior to that. Household employment outcomes have also been materially weaker over the period. The unemployment rate is essentially unchanged since Q2 2025, but the participation rate has fallen almost 0.7ppts over the period, implying an unemployment rate of 5.0% on a constant participation basis. While not an alarming level historically, relative to the average of the past five years, it implies a marked turn in job creation and building downside risks for activity. This is corroborated by the 1.5ppt decline in the household savings rate since April 2025.
Providing a potential offset is record household wealth. Still, with sentiment as it is, and wealth needing to be liquidated or leveraged to be spent, any wealth effect for consumption is likely to take considerable time to materialise. Furthermore, whereas in the past, the use of wealth by higher-income households could have been complemented by tax breaks and/or cash support for those on lower-incomes, US fiscal authorities no longer have capacity outside of recession.
Taken together, current income and wealth dynamics in the US not only suggest growth is at risk of stalling out mid-year, but also that it could remain weak for an extended period. Thankfully, the FOMC remains equipped with the capacity to support the economy should risks to activity become dominant.
As such, it will be important to assess how the FOMC incorporates upcoming inflation detail into their risk calculations. We expect they will be heartened that the Middle East conflict only impacted headline inflation in March, a 10.9% increase in energy prices tripling the total monthly CPI gain to 0.9%, while core inflation printed at a benign 0.2% (core goods prices up 0.1%, and services 0.2%). Although we still believe capacity constraints across the US economy are likely to hold annual core inflation around the 2.6%yr registered in March throughout 2026, this deviation from target is not material enough to preclude further easing if downside risks for the labour market crystallise come Q2 or Q3.
In contrast to the UK and Europe (and Australia and New Zealand), the chance of a policy rate increase is also slim to non-existent in the US. The outlook for short-end rates should therefore limit gains in term yields to a modest upward drift, a function of gradual portfolio reallocation away from US dollar assets and the edging higher of the US fiscal deficit and government debt.
This analysis was initially released in the April edition of Westpac Market Outlook.
