Economic data in the week ahead should highlight a stumble in economic growth and a surge in inflation in the first quarter. While second quarter numbers will likely partly offset both of these trends, they will remind investors of the challenges faced by the Federal Reserve in trying to return the economy to a path of steady growth and moderate inflation. While some Fed officials have advocated very aggressive tightening, both the likelihood of near-term moderation in growth and inflation and longer-run disinflationary forces suggest it would be wiser for the Fed to take a slow and steady approach in battling inflation.
On the growth side, the key release this week will be first quarter real GDP, due out on Thursday. We currently expect a sharp deceleration to 0% growth from a 6.9% gain in the last quarter. It should be noted that this probably overstates any underlying deceleration in the U.S. economy and mostly reflects some very sharp swings in inventories and trade.
Looking at GDP from the demand side, we estimate a very solid 4.7% gain in real consumer spending in the first quarter, driven mainly by gains in leisure, entertainment and travel as pandemic effects faded and some increase in light-vehicle sales from supply-constrained levels in the fourth quarter. We estimate that fixed investment spending rose by an even stronger 13.2% annualized, as companies took advantage of low interest rates and strong profit gains. Investment spending gains should have been very broad-based, across equipment, construction and R&D.
However, it appears that government spending lagged behind, growing by less than 1.0% annualized. Employment across federal, state and local government grew by a modest 46,000 or 0.8% annualized in the first quarter and is still down by more than 700,000 from pre-pandemic levels. It may be that, in an economy that is chronically short of labor, the government sector just doesn’t have the flexibility in compensation to fill vacant positions. Similar issues may have impacted public construction, which in January and February was essentially unchanged from the fourth quarter in nominal terms and down when adjusted for inflation.
More importantly, both inventories and trade were likely major drags on first-quarter GDP.
According to the Bureau of Economic Analysis, real inventories grew at a record $193.2 billion pace in the fourth quarter, converting a modest 1.4% gain in real final sales into a 6.9% increase in real GDP. Annual revisions, due in late July, may well reduce this estimate. However, for now the fourth quarter estimate stays in place and any reduction in real inventory accumulation will detract from first quarter economic growth.
Such a reduction seems quite likely based on both a slower pace of accumulation in nominal inventories in January and February and significantly higher wholesale inflation. March reports on durable goods and wholesale and retail inventories, due out tomorrow and Wednesday respectively, should allow economists to tighten their estimates of first-quarter inventories. However, for now, we estimate only $90 billion in real inventory accumulation in the first quarter, subtracting more than 2 percentage points from real GDP growth.
International Trade should also be a big negative in the GDP report reflecting both the strength of U.S. consumer demand and some of the impact of a rising U.S. dollar. In January and February combined, nominal imports of goods and services were up 19% annualized from the fourth quarter while exports were up just 1%. Moreover, export prices rose more quickly than import prices in the first quarter, implying a more significant deterioration in the real trade numbers than in the nominal numbers. Data due out on Wednesday showing flash estimates of goods trade in March should allow for more precise estimates. However, based on what we know now, it appears that the real trade deficit jumped from a record $1.35 trillion annualized in the fourth quarter to a new record of $1.48 trillion in the fourth, lopping another 2.5 percentage points from GDP growth.
Summing up the demand components, this suggests 0% real GDP growth in the first quarter, which may well lead to further worries about stagflation.
It is also worth noting that these numbers will take a bite out of pandemic-era productivity gains. One small silver lining in the very dark cloud of the pandemic recession is that productivity appeared to rise substantially, presumably due to the adoption of more efficient on-line shopping or using remote communications in place of physical meetings. In 2020 and 2021 combined, the output per hour of the non-farm business sector grew by 2.3% annualized, more than twice the 1.0% annualized pace achieved over the prior 10 years.