GDP Contracts in Q1 on Falling Net Exports and Inventories, but Underlying Demand Trend Remains Positive for Now

Key Takeaways:

• Gross domestic product (GDP), adjusted for inflation, declined at a 1.4 percent seasonally adjusted annualized rate (SAAR) in Q1 2022 after growing at a 6.9 percent SAAR in Q4 2021, according to the Bureau of Economic Analysis (BEA). The contraction was due primarily to a whopping 3.2-percentage point drag from real net exports (exports fell 5.9 percent, while imports jumped 17.7 percent). Additionally, following a surge in Q4, slower inventory investment dragged 0.8 percentage points on GDP. Government spending declined at an annualized rate of 2.7 percent, dragging GDP down an additional 0.5 points. Consumer and investment demand, however, remained relatively strong. Real personal consumption expenditures increased at an annualized rate of 2.7 percent, the fastest rate in three quarters. Additionally, nonresidential fixed investment surged at a 9.2 percent annualized rate, and residential fixed investment grew at a 2.1 percent annualized rate.
• Personal income, adjusted for inflation, fell 0.4 percent in March, according to the BEA. Excluding transfer payments, real personal income ticked up 0.1 percent. The saving rate declined six-tenths to 6.2 percent, its lowest level since 2013. Real disposable personal income declined 0.4 percent, its tenth decline in the past 12 months and its lowest level in two years. The PCE price index increased 0.9 percent in March and was up 6.6 percent over the year. Core PCE increased 0.3 percent over the month for the second consecutive month and was up 5.2 percent on an annual basis, a slight deceleration from February.
• Durable goods orders increased 0.8 percent in March, according to the Census Bureau. Orders for motor vehicles and parts surged 5.0 percent but were largely offset by declines in orders for aircraft. Excluding transportation equipment, durable goods orders were up 1.1 percent and core capital goods orders (nondefense excluding aircraft) rose 1.0 percent.
• The Conference Board Consumer Confidence Index declined 0.3 points in April to 107.3. Confidence in the present situation declined 1.2 points to 152.6, while consumer expectations for the future ended a three-month slide by increasing 0.5 points to 77.2, still the second lowest level since 2013.
• The National Association of REALTORS® Pending Home Sales Index, which records contract signings of existing homes and typically leads closings by one to two months, fell 1.2 percent in March, the fifth consecutive monthly decline. At 103.7, the index is now below the 2019 average.
• New single-family home sales declined 8.6 percent to a SAAR of 763,000, the third consecutive monthly decline, though both the January and February numbers were revised upward. The number of homes for sale increased 3.8 percent to 407,000, though 105,000 of those are not started (an increase of 8.2 percent).
• The FHFA Purchase-Only House Price Index, reported on a seasonally adjusted basis, increased 19.4 percent from a year ago in February, an acceleration of 1.1 percentage points from January and the fastest annual growth rate on record.

Forecast Impact:

First quarter GDP was below our expectations, but it did not fundamentally change how we are thinking about the near-term strength in the economy, nor is it likely to significantly alter our near-term forecast. The weakness in part reflects volatility in the measure following an unsustainable surge in Q4 2021 GDP of 6.9 percent annualized, as well as oscillation in global supply chain disruptions and COVID-related effects over the last six months. These have led to heightened volatility in international trade and business inventory restocking. Smoothing out some of the noise by averaging the past two quarters of GDP change comes to 2.7 percent annualized growth, which we believe to be closer to the underlying growth trend at the moment.

While real net exports fell in Q1, sales to private domestic purchasers increased at a solid 3.7 percent annualized rate, a 1.1 percentage point acceleration from Q4. Business inventory growth also slowed in Q1, but this was due to the unsustainably high growth level in Q4; in dollar terms, real inventory investment had its second strongest quarter since 2015. Therefore, we do not view the Q1 contraction as an “early start” to the modest recession call we made in our April forecast for the second half of 2023. PCE, though somewhat weaker than expected, continued to grow at a steady pace. Further, business fixed investment accelerated in line with our expectations, and we expect investment to remain strong in the near term as the cost of labor continues to increase and capacity utilization remains high. We believe the Fed will view the headline GDP number as a blip in light of a continued tight labor market and heightened inflation. Therefore, we continue to expect a 50-basis point hike in the federal funds rate next week.

More worrying is the continued decline of the personal saving rate to levels now significantly below that which preceded the COVID outbreak. Real disposable income has been trending downward and experienced its largest monthly decline since the extended unemployment benefits expired in September 2021. Core PCE inflation decelerated over the month as expected, supporting our view that eventually inflation will slow sufficiently for real incomes to stabilize. However, there remains heightened uncertainty regarding energy and food prices, which continue to eat into households’ disposable incomes.

The first quarter saw 814,000 new homes sold on a quarterly annualized basis, the highest in a year and slightly above our expectations. While we expect the rise in mortgage rates to eventually weigh on sales, the current strength of demand juxtaposed against large construction order backlogs should dampen the effect of higher mortgage rates in the near term, as there appears to be significant unmet home purchase demand. For existing homes, another pullback in pending sales is supportive of our forecast for declining existing home sales through the end of the year. However, similar to the dynamic with new homes, we believe many buyers who were previously outbid are still in the market for a home, which should help support sales and limit the pace of slowdown in Q2.

Nathaniel Drake
Economic and Strategic Research Group
April 29, 2022

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