US growth turns negative as the Fed prepares for a series of rate hikes

The US economy contracted unexpectedly in the first quarter on a resurgence in Covid-19 cases and a fall in government pandemic aid funds.

However, 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 rates by 50 basis points next week. 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.”

GDP fell an annualized 1.4 percent in the most recent quarter, the government said in its GDP flash estimate. 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,” he said. “While last quarter’s growth estimate was impacted by technical factors, the United States is facing the challenges of Covid-19 around the world, Putin’s unprovoked invasion of Ukraine and global inflation from a position of strength.”

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 3.2 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. Even with food and fuel prices rising, there is still no sign of consumers pulling out.

Strong wage increases amid tight labor market and at least 2 trillion USD (1.9 trillion EUR) 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 hit by inflation, have shown more resilience.

Still, concerns remain that the Fed could aggressively tighten monetary policy and push the economy into recession over the next 18 months.

But much would depend on how quickly geopolitical tensions and supply chains ease, and whether inflation eases. US growth turns negative as the Fed prepares for a series of rate hikes

Fry Electronics Team

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