Growth in U.S. Trails Forecasts as Defense Spending Falls

The U.S. economy grew less than forecast in the first quarter as a drop in defense outlays undercut the biggest increase in consumer spending in two years.

Gross domestic product rose at a 2.5 percent annualized rate following a 0.4 percent fourth-quarter advance, according to data from the Commerce Department issued today in Washington. The median estimate of 86 economists surveyed by Bloomberg called for a 3 percent gain.

Another report today showed consumer confidence fell in April, signaling that households, which sustained spending last quarter by dipping into savings, may not be able keep shopping at the same pace as tax increases start to pinch. Across-the board cutbacks in federal government spending that took effect in March will also take a toll on growth.

“It is encouraging that the consumer maintained a relatively solid pace of spending despite the headwinds,” said Russell Price, senior economist at Ameriprise Financial Inc. in Detroit, the best payroll forecaster in the past two years, according to data compiled by Bloomberg. “We’ll see a bit of deceleration this quarter. The payroll tax is still weighing on consumers, and March’s weaker employment numbers are not going to be friendly for spending.”

Stocks fell amid disappointing corporate earnings reports and the economic data. The Standard & Poor’s 500 Index dropped 0.2 percent to 1,582.24 at the close in New York. Treasuries rallied, sending the yield on the benchmark 10-year note down to 1.66 percent from 1.71 percent yesterday.

Survey Results

U.S. GDP forecasts in the Bloomberg survey ranged from 1 percent to 3.8 percent. Today’s release is the first of three for the quarter, with the other releases scheduled for May and June when more information becomes available.

Consumer spending, accounting for about 70 percent of the economy, climbed at a 3.2 percent pace in the first quarter, the most since the fourth quarter of 2010.

Danielle Colbert, a 33-year-old from southern Maryland, said she is shopping for home goods, frequenting stores like Pier 1 Imports Inc., Regency Furniture Inc. and Macy’s Inc. She and her husband, both government employees, built a house last year, taking advantage of low interest rates.

The economy is improving “very, very slowly” as home prices appreciate, said Colbert, who was looking at clothes in the women’s department of Macy’s.

Sentiment Falls

Not all consumers are as upbeat. The Thomson Reuters/University of Michigan final index of consumer sentiment declined to 76.4 from 78.6 a month earlier. Nonetheless, the figure exceeded the median projection in a Bloomberg survey which called for a drop to 73.5. The preliminary April reading issued two weeks ago was 72.3.

Americans boosted spending by putting less money in the bank, the Commerce Department figures showed. The saving rate dropped to 2.6 percent in the first quarter, the lowest since the last three months of 2007, from 4.7 percent in the prior period.

Another reason for the slump in saving was that earnings plunged. Disposable income adjusted for inflation dropped at a 5.3 percent annualized rate from January through March, the biggest drop since the third quarter of 2009, after a 6.2 percent gain in the fourth quarter.

In addition to the increase in the payroll tax last quarter, the hit to incomes came after companies accelerated dividend and bonus payments in the fourth quarter.

Stockpiling, Housing

Aside from consumer spending, growth in the first quarter was driven by a rebound in stockpiling and a gain in residential construction.

Government outlays declined for the 10th time in the past 11 quarters, restraining growth. Defense spending dropped at an 11.5 percent annualized pace following a 22.1 percent plunge in the last three months of 2012. That was the biggest back-to-back decline on average since 1954, when the military demobilized after the Korean War.

While the drop over the past six months probably reflects the winding down of military operations in Iraq and Afghanistan, it’s also a harbinger of things to come as across-the-board cuts, or sequestration, take effect.

The lagged effect from a two percentage-point jump in the payroll tax at the start of 2013, and $85 billion in automatic budget cuts that began March 1, may take a toll this quarter. The economy will grow at a 1.5 percent pace, before reaccelerating to an average 2.4 percent rate of expansion in the last six months of the year, according to a separate Bloomberg survey.

The Congressional Budget Office has estimated sequestration alone will reduce GDP this year by 0.6 percentage point.

Less Inflation

The GDP report also showed price pressures remain contained. A measure of inflation tied to consumer spending, the one tracked by Federal Reserve policy makers, rose at a 0.9 percent annualized rate in the first quarter, down from a 1.6 percent gain in the previous three months. Central bankers have said their goal is to keep price increases at about 2 percent.

The lack of inflation means the Fed will probably maintain bond purchases when it meets next week.

“The Fed is missing its growth forecast, the Fed is missing its inflation forecast, and there is some risk that they are going to continue missing on both,” said Kevin Harris, chief economist at Informa Global Markets in New York, who projected GDP would climb at a 2.6 percent pace and is the third-best U.S. growth forecaster over the past two years, according to Bloomberg calculations. “The Fed might have to react. They are going to buy more assets.”

Looking Ahead

CSX Corp., the largest East Coast rail carrier, is among companies looking ahead to a better second half of 2013. Jacksonville, Florida-based CSX reported first-quarter earnings that topped analysts’ estimates.

The key economic indicators “point to slow steady growth in the U.S. economy,” Clarence Gooden, chief commercial officer, said on an April 17 earnings call. “Forward projections show continued slow growth in the near term, with improved growth rates later in the year.”

One area that has seen sustained gains in demand is automobiles. Cars sold at an average 15.3 million annualized rate in the first quarter, the most since the same period in 2008, according to figures from Ward’s Automotive Group.

“The only negative real headwinds we see are higher taxes and potentially lower government spending,” Kurt McNeil, vice president of U.S. sales and service at Detroit-based General Motors Co., said on an April 2 conference call. “Everything else seems to be pretty positive,” he said, mentioning jobs, housing and stock market performance.

Housing Rebound

The housing market also remains a bright spot as borrowing costs near a record low help draw buyers. Residential construction increased at a 12.6 percent annualized rate last quarter, adding 0.3 percentage point to growth, today’s GDP report showed.

Business investment, another contributor to growth, is cooling as sequestration takes hold. Corporate spending on equipment and software climbed at a 3 percent pace from January through March after rising at an 11.8 percent rate in the previous quarter.

Before it's here, it's on the Bloomberg Terminal.