First quarter’s 3.2 percent GDP is not all that it’s cracked up to be
Appearances can be deceiving, and in the case of the first-quarter (Q1) GDP report, that definitely is the case. The headline growth figure of 3.2 percent easily exceeded expectations and is being touted as evidence that economic activity is steaming along.
In fact, while I am more optimistic than most regarding the outlook for the economy for all of 2019, the first quarter was not nearly as strong as today’s release would suggest at first glance.
{mosads}The primary surprise in the Q1 GDP report, at least relative to my projections, was that inventories were accumulated at a pace that was even faster than anticipated. It is no shocker that inventories are high, as firms spent the second half of last year trying to rush imports of goods from China into the country before the next tariff hike deadline.
Usually, imports and inventories tend to move together, as firms hold imported goods (and domestically-produced merchandise as well) either on store shelves or in warehouses for a time after they enter the country and before they are sold.
The first quarter of this year was thus a rare case where both inventories and the net exports category pushed in the same direction. Inventories added roughly a percentage point to growth while net exports added another two-thirds of a percentage point.
The story here is understandable: Exports rebounded in the first quarter as China resumed purchases of U.S. goods, particularly food products, after halting such buys last year in the heat of the tit-for-tat tariff fight.
At the same time, once the March 1 deadline for the U.S. to impose a tariff hike on Chinese goods was postponed indefinitely early last quarter, U.S. retailers and wholesalers no longer had an incentive to stockpile goods.
Thus, imports fell in real terms from the inflated levels of late last year. Even so, nonfarm inventories continued to accelerate in Q1, which I suspect may mean that there were imported goods that failed to get counted as inventories right away late last year (perhaps they were still in transit?).
In any case, real final sales to domestic purchasers, which is simply GDP minus inventories and trade, provides not only a more stable gauge of economic activity but also more directly addresses the underlying strength of the economy by measuring domestic demand.
That variable rose at only a 1.4 percent annualized pace in Q1, marginally better than I had projected, but the worst quarter since 2015.
Consumer spending growth was soft, as it has been in most recent years in the first quarter. This year, there were plenty of excuses, including:
- the federal government shutdown,
- the fallout from the tightening in financial conditions late last year and
- rough winter weather.
The good news here is that these problems had mostly dissipated by late in the quarter and consumer expenditures bounced back violently in March, setting the stage for a nice rebound in the spring.
Last year, real consumer spending rose by only 0.5 percent in the first quarter and then zoomed higher by 3.8 percent in the second quarter. This year, the 1.2 percent first-quarter advance may be followed by another gain of almost 4 percent.
Similarly, business investment was lackluster in the first quarter, registering a 2.7-percent advance, reflecting many of the same uncertainties that clouded the consumer outlook in January and February.
However, the stage has already been set for a spring pickup, as an underlying gauge of capital goods orders rose in each of the first three months of 2019 after falling in four of the last five months of 2018 (orders tend to lead actual investment by a quarter or two).
Even the downtrodden housing sector, which posted a fifth-straight quarterly decline in real terms, has shown signs of life lately. Builders and realtors are pointing to a pickup in demand for homes in the spring on the back of moderating home price rises and a fall in mortgage rates.
Finally, the government sector managed to post a gain in the first quarter despite the government shutdown thanks to a rebound in state and local government outlays on roads and the ongoing rise in defense spending.
While state and local government outlays may not repeat the Q1 surge, the return to normal federal government operations should add 0.4 percentage points to growth in the spring.
Thus, there is reason to expect strength out of every major sector of domestic demand in the second quarter. As a result, the Q2 headline GDP figure may cool a bit, perhaps to just below 3 percent, but underlying activity is poised to strengthen sharply after a difficult start to the year.
In any case, what matters more than how the data get sliced up on a quarterly basis is that real economic growth in the first half of this year may sustain close to the 3 percent pace recorded in 2018, a performance far better than most economists (and Fed officials) currently project.
Stephen Stanley is the chief economist for Amherst Pierpont.