PUBLISHED THU, APR 28 20221:27 PM EDT
Jeff Cox
Technically speaking, the negative economic growth in the first quarter looks like the U.S. is halfway down the road to recession.
After all, the generally accepted definition of a recession is two consecutive quarters with a minus sign before the GDP number.
A look under the hood, though, suggests the U.S. is probably still a good ways from there, but the trend is not necessarily encouraging.
The 1.4% GDP loss for Q1 came about primarily because one key factor that fueled strong gains in the previous two quarters — an inventory rebuild in the back half of 2021 went in the other direction to start the year. On top of that, the record-breaking trade deficit subtracted from the topline, while surging prices and early year omicron infections also probably held back some activity.
But the U.S. is by and large propelled by consumption, not production, and by that measure the economy still looks solid.
“We are not surprised nor concerned by the decline in overall GDP growth in Q1, even if the decline is the first since the height of the pandemic in Q2-2020,” Citigroup economist Veronica Clark wrote. “We do not expect another decline in GDP in Q2, with the economy avoiding a technical recession of two quarters of negative growth.”
Personal consumption expenditures, the primary gauge of household spending within the GDP report, rose 2.7% in the January-through-March period. That was a touch softer than the chatter around Wall Street but still represented an upgrade over the past two quarters.
The record $89.2 trillion trade deficit, fueled by rising imports, drained 3.2 percentage points from the GDP total. Imports are considered a subtraction in the math the Bureau of Economic Analysis uses to compute the total figure.
But there was a bright spot there, said Clark, who noted that rising imports “are a mechanical drag on GDP growth but, in our view, are a positive sign of still very strong domestic demand.”
Inflation shows up strong
That demand has come despite surging prices that were reflected in Thursday’s report.
The GDP price deflator index jumped 8%, as goods prices soared 11.8%, a sign that services demand still lags in the pandemic environment. Nondurable goods in particular jumped 14.9% in price as consumers shift purchases away from longer-lasting purchases.
It’s that inflation specter that scares economists most.
Deutsche Bank, for instance, is looking for a “significant recession” to the hit the U.S. in late 2023 or early 2024, the result of Federal Reserve interest rate hikes more aggressive than the market is currently anticipating. That’s an outlier forecast; the more consensus view on Wall Street comes from Goldman Sachs, which sees recession risks rising but still only about a 35% chance of a downturn, and that’s at least a year from now.
But a significant dent in consumer spending would be ominous for an economy in such a tenuous position.
Paul Ashworth, chief North America economist at Capital Economics, pointed out that spending decelerated in February and March after jumping in January. Overall, he expects GDP to grow 2% in the second quarter but only 2.4% for the full year — not a recession, but certainly not the gangbuster 5.9% gain in 2021 that was the best since 1984.
“That suggests the fading of the Omicron wave has provided little boost and sets up for a much weaker showing in the second quarter, particularly with real personal disposable income down another 2% annualized in the first quarter,” Ashworth wrote. “The saving rate fell to only 6.6%, leaving it well below the pre-pandemic level, at a time when higher interest rates and the uncertainty created by elevated inflation have probably raised desired saving.”
A possible pause from the Fed
Virtually all economists figure the Fed is still well on track to raise interest rates 50 basis points next week. The central bank is then expected to hike by another 75 basis points in July before slowing down but with the year still ending with the benchmark fed funds rate between 2.75%-3%, from its current 0.25%-5% range.
If growth remains slow, though, that could change the rate outlook quickly.
“Eventually, not immediately but perhaps later in the year, there might be both an opportunity and a need to recalibrate the high [rate] path,” said Simona Mocuta, chief economist at State Street Global Advisors. “The Fed should remain nimble as they say they are, and data dependent.”
Mocuta took a dimmer view of Thursday’s report. She sees the economy shifting from one driven by outsized goods demand during the early pandemic days to more normal patterns that suggest softer growth.
She actually sees inflation also getting tamped down, as rate hikes could reduce demand and allow supply chains to catch up — an ideal situation for the Fed, and one not in keeping with dramatically higher interest rates.
For the market’s part, investors stayed positive despite the negative print. Stocks leaped in early afternoon trading, and government bond yields came well off their earlier highs.
“To me, this print was more worrisome because it highlights the process of normalization that’s very timid at the moment but should surely accelerate in the next few quarters,” Mocuta said. “I would disagree with the initial market reaction. But let’s see what happens.”