US: GDP Growth Not Quite as Strong in Q1 as Headline Suggests

Fundamental analysis of Forex market

Inventories and net exports made sizeable contributions to overall GDP growth in Q1. With price pressures muted, the Fed probably won’t be raising rates anytime soon, stronger-than-expected growth notwithstanding.

Some Temporary Factors Lift Overall GDP Growth

U.S. real GDP grew at an annualized rate of 3.2% in Q1-2019 relative to the previous quarter (top chart). Not only was the headline rate of growth stronger than most analysts expected, but it also represents a pick-up in growth relative to the 2.2% rate of growth that the economy registered in the fourth quarter. That said, the underlying details were not quite as strong as the headline rate of growth suggests.

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For starters, there was a sizeable build of inventories ($128 billion at an annualized rate), which added 0.7 percentage points to topline GDP growth. Given the lackluster rate of domestic final spending (see below), some of this inventory build likely was unintentional. Therefore, inventory accumulation should fall back in coming quarters, which will exert a headwind on the overall rate of GDP growth at that time. Second, net exports added 1.0 percentage point to the overall rate of growth, which is among the largest positive contributions this component has made in this cycle (middle chart). Although exports grew at a modest rate of 3.7%, imports fell 3.7%. Given continued growth in domestic demand, real imports likely will rebound in coming quarters, which also will exert a drag on growth.

As noted above, domestic demand continued to grow in the first quarter, albeit at a modest pace. Real personal consumption expenditures (PCE) rose only 1.2% in Q1, and fixed investment spending was up only 1.5%. Indeed, final sales to private domestic purchases—a measure of the underlying strength of the domestic economy—rose just 1.3%, which is the slowest rate of growth in this component in nearly six years. That said, final domestic spending should accelerate somewhat in coming quarters. Real PCE ended the first quarter on a strong note, which gives it momentum heading into Q2, and durable goods orders data for March, released yesterday, suggest that capital spending could be picking up. Although the economy may not have been as strong in the first quarter as the headline GDP growth rate suggests, the economy is not in danger of stalling anytime soon.

Price Pressures Remain Muted

In our view, today’s stronger-than-expected GDP print does not materially change the outlook for Fed policy, at least in the near term. That is, the FOMC likely will refrain from raising rates for the foreseeable future. First, the underlying details were not as strong as the headline rate of GDP growth suggests. Second, the core PCE deflator rose at an annualized rate of just 1.3% in the first quarter. Consequently, this measure of consumer prices was up just 1.7% on a year-over-year basis in the first quarter (bottom chart). With the Fed’s preferred measure of consumer price inflation remaining below its objective of 2%, it seems likely that the FOMC will be happy to remain on the sideline watching the incoming data.

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