US growth reverses as Fed prepares to raise rates

The US economy unexpectedly contracted in the first quarter amid a resurgence in COVID-19 cases and falling government money to help the pandemic, but the decline in output is misleading as the domestic demand remained strong.

he first decline in gross domestic product in nearly two years, reported by the Commerce Department on Thursday, was mainly driven by a broader trade deficit as imports rose and a slowdown in the pace of inventory buildup from strong fourth quarter rate.

A measure of domestic demand accelerated from the pace of the fourth quarter, allaying fears of stagflation or recession. The Federal Reserve is expected to raise interest rates by 50 basis points next Wednesday. The US central bank raised its official interest rate by 25 basis points in March and is likely to start trimming its asset holdings soon.

“The economy still shows some resilience, but the first-quarter GDP report signals the start of more moderate growth this year and next, largely in response to higher interest rates,” said Sal Guatieri, senior economist. of BMO Capital Markets in Toronto. “Despite the contraction, the Fed has no choice but to hike aggressively in May to contain inflation.”

Gross domestic product fell at an annualized rate of 1.4% last quarter, the government said in its flash estimate of GDP. The economy grew at a solid 6.9% pace in the fourth quarter.

US President Joe Biden said he was not worried about a recession after the data was released.

“The American economy, fueled by working families, continues to be resilient in the face of historic challenges,” Biden said in a statement. “While last quarter’s growth estimate was affected by technical factors, the United States faces the challenges of Covid-19 around the world, Putin’s unprovoked invasion of Ukraine, and global inflation from a position of strength. “.

Last quarter, the economy was also hit by supply chain challenges, worker shortages and runaway inflation. Still, output remains 2.8% above its level in the fourth quarter of 2019. When measured year over year, the economy grew 3.6% in the first quarter.

Imports rose, in part due to early loading by companies fearful of shortages due to the Russian-Ukrainian war. At the same time, exports plummeted. That led to a sharp widening of the trade deficit, which subtracted 3.20 percentage points from GDP growth. Trade has now been a drag on growth for seven straight quarters.

Companies have turned to imports to meet demand, and local manufacturers lack the capacity to boost production. Although businesses continued to replenish, the pace has moderated from the fourth quarter, resulting in a reduction in inventory investment of 0.84 percentage point of GDP growth.

Growth in consumer spending, which accounts for more than two-thirds of US economic activity, rose to a 2.7 percent rate from the 2.5 percent pace in the fourth quarter, despite take a hit from the winter wave of coronavirus cases, fueled by the Omicron index. variant. Even with food and gasoline prices soaring, there is still no sign that consumers are backing down.

Strong wage gains amid an increasingly tight job market and at least $2 trillion in excess savings accumulated during the pandemic are providing a cushion against inflation. According to data from Bank of America Securities, low-income consumers, who tend to be disproportionately affected by inflation, showed greater resilience.

Strengthening labor market conditions were bolstered by a separate Labor Department report on Thursday that showed initial claims for state jobless benefits fell 5,000 to a seasonally adjusted 180,000 for the week ending April 23.

Economists had forecast 180,000 applications for the last week. Business investment accelerated, with equipment spending rising at a 15.3% rate last quarter.

That, combined with strong consumer spending, boosted final sales to private home buyers at a rate of 3.7%. This measure of domestic demand, which excludes trade, inventories and government spending, increased at a rate of 2.7% in the fourth quarter. Final sales to private domestic buyers account for approximately 85% of total spending.

Still, concerns remain that the Fed could aggressively tighten monetary policy and push the economy into recession in the next 18 months. The housing market is already showing signs of slowing, with the 30-year fixed mortgage soaring above 5 percent.

But much would depend on how quickly geopolitical tensions and supply chains ease, and whether inflation subsides.

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