An echo of what might have been is the best way to understand the initial estimate of U.S. gross domestic product for the first quarter as growth expanded at a 2% pace.
That growth was driven by a 1.6% increase in household consumption and a 10.4% rise in nonresidential investment while net exports exerted a 1.3% drag on overall economic activity.
A year that was set to benefit from tailwinds associated with a large tax cut and a boom in artificial intelligence investment has been partially offset by the supply shock caused by the war in Iran.
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The underlying pace of growth using our preferred metric—final sales to private domestic purchasers excluding inventory accumulation and trade—was 2.5%, and that figure captured where the economy had been heading on the back of AI investments and the tax cuts.
But the Iran war and the supply shock that ensued has changed that story.
We recently lowered our GDP forecast for the year from 2.4% to 1.7%, primarily because of the 56% increase in West Texas Intermediate, the North American benchmark for oil, and the 44% jump in gasoline, all of which will push inflation toward 4% and 4.5% this year.
In a separate data released Thursday, the personal consumption expenditures price index for March increased by 0.7% and rose by 3.5% over the past year. The core rate advanced by 0.3% and was up by 3.2% from a year ago.
Personal income increased by 0.6% and spending advanced by 0.9% in March. Inflation-adjusted personal spending increased by 0.2%.
Given the notable jump in oil and gasoline prices as well as the passing through of transportation costs downstream, we expect a strong increase in inflation in April that will result in a slower pace of growth.
In addition, negative real wage growth and declining inflation-adjusted disposable income will contribute to the demand destruction that is underway across the American economy.
It is clear based on the recent Federal Open Market Committee meeting that central bankers are engaged in a fierce debate over inflation, growth and interest rates.
At this point, we tend to lean toward the risk to price stability given global and geopolitical dynamics, which is why we expect no rate cuts this year. We think a rate hike may be needed if the war does not end soon.
Whatever the case, the story of the American economy is now one that points toward stagflation defined by demand destruction, an outright decline in real wage growth and the risk of rising unemployment.
The data
Nonresidential investment increased by 10.4% in the first quarter, which was the primary catalyst for the 8.7% increase in gross private investment. Fixed investment advanced by 6.2% while outlays on structures declined by 6.7%.
How strong is the AI boom? There was a 17.2% increase in equipment spending and a 13% increase in intellectual property spending, both of which will warm the hearts of economists who look fondly at productivity.
Spending on residential investment dropped by 8%, which captures the conditions in the housing industry.
Exports increased by 12.9% and imports rose by 21.4%. Exports of goods jumped by 18.1% while imports of goods soared by 25.8%. Service exports were up by 4.2% and imports of services advanced by 6.6%.
Government spending increased by 4.4% because of a 9.3% increase in federal spending and a 1.6% gain in state and local outlays. Nondefense outlays increased by 20.3% while defense spending increased by 2.3%.
Real final sales increased by 1.6% while gross domestic purchases advanced by 3.2%. Final sales to domestic purchasers increased by 2.8% and our preferred metric of economic activity—final sales to private domestic purchasers excluding inventory accumulation and exports—increased by 2.5%.
Inventories declined by $7.5 billion during the first quarter.
The takeaway
Growth in the first quarter was fueled primarily by household consumption, which boosted activity by 1.08% and an artificial intelligence-led increase in nonresidential investment that bolstered economic activity by 1.48%. Tariff-induced distortions caused a 1.3% drag on overall growth in the quarter.
The final product was a 2% increase in overall growth, which is modestly above the 1.8% long-term trend.
The economy will do well to expand at trend growth because of the rising headwinds from the supply shock, the onset of a decline in real wage growth and the demand destruction that is following in its wake.
