Growth in the first quarter expanded at a 1.1% annualized pace and by 1.6% on a year-ago basis as a modest inventory correction—a net drag of 2.26%—and a large pullback in business investment—a net drag of 2.34%—offset the robust 3.7% increase in overall household consumption.
This data, while firmly in the rearview mirror, illustrates that American firms are increasingly concerned about the sustainability of the business cycle as the lagged impact of rate hikes, elevated inflation and tighter lending combine to cause the consumer to capitulate and reduce spending this year.
Policy implications
First-quarter economic activity will provide plenty of fodder for both hawks and doves at the Federal Reserve as they spar over whether there will be a near-term policy peak in interest rates following what is expected to be a 10th straight rate hike at its meeting next week.
We expect a 25 basis-point increase, which would bring the Fed’s policy rate into a range of 5% to 5.25%.
All of this implies that the rate will remain above the core policy variable that the central bank uses to set rates—the core personal consumption expenditure deflator, which stood at 4.9% at the end of the first quarter.
These dynamics all point to a monumental decision by the Fed at its meeting in June on whether to continue or pause its rate increases.
The data
While April consumer credit card data suggests that consumption is slowing, household consumption during the first quarter of the year expanded at a gaudy 3.7% pace, driven by an 8% increase in disposable income, according to Commerce Department data released Thursday.
This is why our preferred set of alternative growth metrics below the headline figure remain resilient.
Real final sales increased by 3.4%, while final sales to domestic purchasers were up by 3.2% and final sales to domestic purchasers, which exclude inventories and net exports, advanced at a 2.9% pace. Gross domestic purchases increased by 0.9%.
Outlays on goods increased by 6.5%, driven by an eye-popping 16.9% increase in durable goods spending and a 2.3% increase in demand for services.
The capacity of the American household to respond to easing goods prices remains stout and should result in further squawking from the hawks at the Federal Reserve who are agitating for a rate hike in May and another in June.
Gross private investment declined by 12.5%, residential investment dropped by 4.2% and non-residential investment inched forward by 0.7%.
Fixed investment dropped by 0.4% while outlays on productivity-enhancing equipment fell by 7.3% Outlays on structures increased by 11.2% while investment in intellectual property advanced by 3.8% during the first quarter.
Exports increased by 4.8% on the back of a 10% jump in demand for American-produced goods, more than offsetting the 5.5% decline in services.
Imports increased by 2.9%, driven by a 3.7% advance in purchases of foreign goods and a 0.2% drop in demand for services.
Government consumption increased by 4.7% with federal spending up by 7.8% and state and local outlays rising by 2.9%. Outlays on national defense increased by 5.9% while nondefense spending jumped by 10.3%.
The takeaway
The “R Word” that one should use when discussing the American economy over the past two years should be resilient, not recession.
The shocks of inflation and interest rate increases and a tightening in lending that are now affecting small and midsize businesses have yet to put a material dent in consumption.
That strength is what is propping up overall economic activity as business have pulled back on both inventory accumulation and fixed investment.
