Orlando's Outlook: Another punk first-quarter GDP


Bottom line This morning, the Department of Commerce flashed a much weaker-than-expected first-quarter GDP gain of only 0.7%, its poorest performance in three years. That’s down sharply from the fourth quarter of 2016’s 2.1% increase and the third quarter’s more robust pace of 3.5%. So the economy is clearly trending in the wrong direction. By comparison, the Bloomberg consensus was expecting a 1% gain, the Blue Chip consensus estimate was at 1.4% and we had a slightly more constructive 1.5% estimate here at Federated. Only the Atlanta Fed’s widely-followed “GDPNow” estimate was too pessimistic, at a paltry gain of 0.2%.

There were four problems with today’s disappointing first-quarter results, which was the weakest period since the -1.2% decline in the first quarter of 2014. First, the significant downward seasonal bias to first-quarter GDP persists despite the government’s best efforts to identify and resolve this statistical discrepancy. Second, personal consumption was a disaster, largely driven by a collapse in car sales and a mild winter. Third, inventory accumulation, which had surged in the fourth quarter of 2016, reverted back to a much more tepid pace in the first quarter. Finally, government spending declined for the first time in three quarters. That weakness collectively offset strength from corporate capital investment, housing and net trade.

The good news, in our view, is that second-quarter GDP will snap back sharply to an estimated gain of 2.6%, driven by much-improved consumer-spending trends and stronger inventory accumulation. Consequently, we do not believe the Federal Reserve will be sufficiently discouraged by today’s weak report to dissuade them from hiking interest rates again in June or July.

Here are the key details regarding today’s first-quarter GDP flash report:

Seasonal problems persist Since the Great Recession ended in June 2009, there is a clear downward seasonal bias to first-quarter GDP growth. The eight first quarters since the recession ended and economic growth resumed have produced GDP growth averaging only 1%. But the seven second quarters have averaged 2.5%, the eight third quarters have averaged 2.4% and the eight fourth quarters have averaged 2.6%. So Commerce’s attempts a few years ago to identify the discrepancies causing this imbalance and smooth out the quarterly results have been for naught. GDP growth is still more than 2.5 times faster in the latter nine months of the year, on average, than in the first quarter. So for seasonal reasons alone, we’d expect to see a second-quarter GDP bounce.

Consumer spending plunges Personal consumption expenditures, which account for 70% of GDP, suffered their worst performance since the fourth quarter of 2009, rising by a much weaker-than-expected 0.3%. That compares with consensus expectations for a stronger gain of 0.9% and much more robust increases of 3.5% in the fourth quarter of 2016, 3% in the third quarter and 4.3% in the second quarter, the largest quarterly increase since the fourth quarter of 2014. Today’s paltry gain added only 0.23 percentage points to overall first-quarter GDP growth, compared with a much healthier contribution of 2.4 percentage points to fourth-quarter growth. What caused this first-quarter consumer weakness? We know that auto sales were poor in the first quarter, with aggressive discounting and a surge in subprime auto loans, and our research friends at RDQ Economics estimate a first-quarter auto sales decline of 16% on an annualized basis. Also, with the relatively mild winter (except for winter storm Stella in mid-March), RDQ estimates that spending on energy-related goods and services (utilities and home-heating oil) declined 18%. The late Easter (April 16) and delayed tax refunds also contributed to the consumer weakness. Those latter issues won’t affect the second quarter, of course, which is why we expect a consumer-driven rebound in second-quarter GDP.

Housing accelerates Residential investment leapt 13.7% in the first quarter of 2017, which added 0.5 percentage points to GDP growth, the sector’s strongest contribution since the second quarter of 2015, when it grew 14.9%. By comparison, residential construction grew 9.6% in last year’s fourth quarter and suffered declines of 4.1% and 7.7%, respectively, in last year’s third and second quarters, the latter of which was the largest quarterly decline since the third quarter of 2010. We expect this positive trend to remain firm in light of a solid labor market, rising household formations, low mortgage rates and tight housing inventory.

Inventory rebuild slows The new inventory-restocking cycle that commenced in last year’s third quarter and accelerated in the fourth quarter slowed noticeably in the first quarter of 2017, though inventory accumulation did remain positive. Businesses added only $10.3 billion to inventories in the just-completed first quarter, down sharply from $49.6 billion in the fourth quarter of 2016, which deducted 0.93 percentage points from first-quarter GDP growth (the largest such reduction in three quarters). By comparison in the third quarter, businesses had added $7.1 billion in inventory, so the fourth-quarter’s addition of $49.6 billion in inventory added 1.01 percentage points to GDP. We continue to believe that with the recent leadership change in Washington, we’ll see a more business-friendly set of fiscal policies to stimulate faster inventory accumulation amid stronger economic growth. But the passage of “Trumponomics” likely has been pushed into the fourth quarter of this year, which has had chilling effect on inventory stocking.

Net trade slightly positive The trade deficit shrunk modestly in the first quarter of 2017, adding 0.07 percentage points to GDP. Exports rose 5.8% in the first quarter, which added 0.68 percentage points, as the dollar was modestly weaker during the period. That compares with an export decline of 4.5% in the fourth quarter of 2016 and an unsustainable 10% third-quarter surge in exports (related to that now-famous soybean sale to China). Imports rose 4.1% in the first quarter of 2017, which subtracted 0.61 percentage points from GDP. By comparison, imports soared 9% in the fourth quarter of 2016 and rose a more modest 2.2% in its third quarter.

Corporate capex bounces Nonresidential real business fixed investment rose for the fourth consecutive quarter by a strong 9.4% in the first quarter of 2017, which added 1.12 percentage points to GDP. That compares with modest gains of 0.9% in the fourth quarter and 1.4% in the third quarter. Looking at the key components, business equipment and software rose for the second consecutive quarter (after four straight down quarters), gaining 9.1% in the first quarter of 2017, which added 0.49 percentage points to GDP. That compares with a gain of 1.9% in the fourth quarter and a decline of 4.5% in the third quarter. Moreover, business structure investment—a very volatile category that includes factories and office buildings—soared 22.1% in the first quarter, adding 0.55 percentage points, compared with a decline of 1.9% in the fourth quarter and a gain of 12% in the third quarter. Intellectual property spending rose 2% in the first quarter, adding 0.08 percentage points to GDP, versus gains of 1.3% in the fourth quarter and 3.2% in the third quarter. We continue to expect corporate capex investment to accelerate under President Trump’s fiscal policies.

Government spending falls Total government spending, which accounts for about 17% of total GDP, declined for the first time in three quarters by 1.7% in the first quarter of 2017, subtracting 0.3 percentage points from growth. That compares with modest gains of 0.2% in the fourth quarter and 0.8% in the third quarter. Digging into the mix shift, Federal government spending declined 1.9% in the first quarter, paced by a 4% decline in defense spending, while state and local spending collectively fell 1.6%.