Investment Buoyed U.S.'s Weak Growth
The first-quarter gross domestic product report released Friday showed that the U.S. economy experienced the weakest pace of growth since the first quarter of 2014. In addition, personal consumption expenditures, which have carried growth during a recent investment recession, faltered, and were at the slowest pace since the fourth quarter of 2009. Expectations for this year’s first-quarter report fell significantly over the past two months, and the 0.7 percent pace of quarter-over-quarter annualized GDP growth was a disappointment, but not a shock.
This weak level of growth puts a rate-hike decision by the Federal Reserve on hold until September, and introduces significant downside risks to the dollar, as well as upside risks for gold prices.
Even so, there was a bright spot: Business investment -- which was in recession from the fourth quarter of 2015 through the second quarter of 2016 -- has improved significantly over the past three quarters, and it took the lead in the first-quarter report. Equipment purchases rose by 9.1 percent -- the fastest pace since the third quarter of 2015. This confirms what the ISM Manufacturing Index and the MHI Business Activity Index surveys have been showing: Business are betting on more growth, and they are making investments to prove it.
But the GDP report also presents a troubling question: Where was the personal consumption? Spending slowed sharply in the first quarter to just 0.3 percent -- the slowest pace since the fourth quarter of 2009. Although durable goods purchases were weak and fell by 2.5 percent quarter over quarter (reflecting a drop in auto sales), nondurable goods also slowed sharply. Plus, even services growth decelerated to the slowest pace since the first quarter of 2013.
As consumption slowed, investment essentially accounted for all of the 0.7 percent pace of first-quarter growth. Despite a strong inventory drawdown, investment (net of inventories) added 0.69 percentage points to GDP, while the much smaller positive contributions from consumption (0.23 percentage points) and net exports (0.7 percentage points) were offset by a drop in first-quarter 2017 government expenditures (minus 0.30 percentage points).
Inventories, imports, and government spending can be choppy contributors to GDP, but with close to full employment and still relatively low interest rates, it is surprising that consumption slowed so significantly in the first quarter.
A number of recent articles have discussed the tendency for first-quarter GDP reports to underperform, and there have been lots of suggestions that the methods used to calculate the data might need some adjustments. But even if that were true, the declines in first-quarter 2017 auto sales were real -- and the slowing of consumption has been the worst in four years. So, even if the data adjustments need refreshing, this was still a weak quarter relative to other first quarters. As such, market participants who are quick to dismiss the weak first-quarter GDP report purely as an anomaly, may be overly optimistic about second-quarter GDP growth.
Given the sharp drop in first-quarter auto sales, those will be critical numbers to watch for consumption in the future. Tax policy will also be important for investment, which has become a more important component of the GDP mix, given that it carried the first quarter. This GDP report raises the odds for getting tax cuts passed along with increased spending -- but it also increases the stakes.
The Donald Trump administration has been touting tax cuts, which is a big reason why optimism and business investment rose sharply in the first quarter. Although there is likely to be a healthy debate over the Trump administration’s proposed government budget in coming months, the weak first-quarter GDP report could help get otherwise challenging levels of increased deficit spending -- as well as hotly anticipated corporate tax cuts -- through Congress and made into law. If the corporate tax cuts do not come, however, the risk of recession would rise significantly.
There have been 14 recessions since 1928 -- including the Great Depression, the 2008 downturn, and 12 others in between. Of those 14, 11 were post-election recessions with a median start of just eight months after a presidential election. Month six begins on May 1. If fiscal policy falters, and business investment disappoints, the downside risks could be significant.
Tax cuts and more deficit spending would also likely engender inflation, but without the stimulus, growth could falter. Since the pace of growth and investment hinges on getting tax cuts and increased spending through Congress, the Fed is likely to leave rates on hold until the picture becomes clear. That isn’t likely until September, which presents further near-term downside risks for the dollar and upside risks for gold prices -- especially if the debate heats up, and doubts intensify.
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