On Wednesday the Commerce Department made a shocking announcement: The U.S. economy grew at an annual rate of just 1.8% in the first quarter. This fell far short of economists’ expectations of a 2.4% increase. What caused the downward revision was decelerating consumer spending. In the first quarter, taxes took a bigger chunk out of Americans’ wallets than expected. Now economists expect growth to slow to a 1.7% pace before heating up in the second half of the year.
In the wake of this report, the stock market did something very interesting…it rallied! The Dow, the S&P 500 and the NASDAQ all shot up over 1% today. Believe it or not, there is a reasonable explanation for this.
Under normal circumstances, such a lukewarm report would make investors uneasy or even spark a selloff. But we are not in a normal market environment—the Federal Reserve has seen to that. For years on end, the Fed has been propping up the stock market with its easy money policy (QE). The mere suggestion that the Fed would tighten the fiscal pump sooner than expected sent the markets in a downward spiral last week.
But as I covered last week, the expiration of QE is contingent on whether the unemployment rate falls all the way to 6.5% by mid-2014. And with the U.S. economy only inching ahead, it appears less and less likely that we will hit that employment target within the next year.
To put it into perspective, the U.S. economy grew by at least 3.5% in the pre-recession years (2004-2007). The Fed is forecasting at least a 3% annual pace for 2014 and 2015. But as you can see by the chart above, Gross Domestic Product (GDP) has grown at a 3% annual pace (or more) for only two of the past 13 quarters! And this trend probably won’t change anytime soon.
The general opinion—supported by Wednesday’s report—is that GDP is not growing fast enough to lower the overall unemployment rate to 6.5%. Because Wall Street is obsessed with the Fed and Quantitative Easing, this is why the market rallied.