US growth reverses as Fed prepares for rate hike


The US economy contracted unexpectedly in the first quarter on a resurgence in COVID-19 cases and a fall in government aid to the pandemic, but the fall in output is misleading as domestic demand remained strong.

The first contraction in gross domestic product in nearly two years, reported by the Commerce Department on Thursday, was mainly due to a broader trade deficit as imports surged and a slowing pace of inventory building from the robust pace of the fourth quarter.

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

“The economy is still showing some resilience, but the Q1 GDP report signals the start of more moderate growth this year and next, mainly in response to higher interest rates,” said Sal Guatieri, senior economist at BMO Capital Markets in Toronto. “Despite the contraction, the Fed has little choice but to hike aggressively in May to curb inflation.”

Gross domestic product fell an annualized 1.4 percent in the most recent quarter, the government said in its GDP forecast. The economy grew at a robust pace of 6.9 percent 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 — remains resilient in the face of historic challenges,” Biden said in a statement. “While last quarter’s growth estimate was impacted 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.”

In the last quarter, the economy was also hit by supply chain challenges, labor shortages and rampant inflation. Still, production remains 2.8 percent above its level in the fourth quarter of 2019. Year-on-year, the economy grew 3.6 percent in the first quarter.

Imports skyrocketed, in part due to upfront spending by companies fearing shortages from the Russia-Ukraine war. At the same time, exports collapsed. This led to a sharp widening of the trade deficit, which deducted 3.20 percentage points from GDP growth. Trade has now held back growth for seven consecutive quarters.

Businesses have turned to imports to meet demand, with local manufacturers unable to boost production. Although companies continued to build inventories, the pace slowed from the fourth quarter, leading to inventory investment dragging 0.84 percentage points off GDP growth.

Consumer spending growth, which accounts for more than two-thirds of U.S. economic activity, rose to 2.7 percent from 2.5 percent in the fourth quarter, despite being hit by the winter wave of coronavirus cases fueled by the Omicron variant . Even with food and gas prices soaring, there are still no signs that consumers are retreating.

Strong wage increases amid tight job market and at least 2 trillion USD in excess savings accumulated during the pandemic provide a cushion against inflation. According to data from Bank of America Securities, low-income consumers, who tend to be disproportionately hit by inflation, have shown more resilience.

The strengthening in labor market conditions was bolstered by a separate Labor Department report on Thursday showing initial jobless claims fell by 5,000 to a seasonally adjusted 180,000 in the week ended April 23.

Economists had forecast 180,000 applications for the past week. Business investment accelerated, with equipment spending rising 15.3 percent in the most recent quarter.

This combines with solid consumer spending to boost final sales to private domestic buyers at a rate of 3.7 percent. This metric of domestic demand, which excludes trade, inventories and government spending, rose 2.7 percent in the fourth quarter. Final sales to private domestic buyers account for approximately 85 percent of total spend.

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

But much would depend on how quickly geopolitical tensions and supply chains ease, and whether inflation eases. US growth reverses as Fed prepares for rate hike

Fry Electronics Team

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