US economy contracts for first time since mid-2020

The US economy contracted unexpectedly in the first quarter, as a record-high trade imbalance and weaker inventory growth masked strong spending by American consumers and businesses.

The US commerce department reported that gross domestic product dropped 1.4 per cent on an annualised basis in the first quarter, down significantly from the 6.9 per cent rise recorded in the fourth quarter of 2021.

That marks the first contraction of the economy since mid-2020, when Covid-19 lockdowns had curtailed activity.

The data translate to a 0.4 per cent fall compared with the previous quarter, based on a measure used by other major economies.

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Deficit

The GDP figure was pulled lower by a growing trade deficit, which hit a record high in March as import volumes and prices surged. The robust import demand, and change in the trade deficit, detracted from GDP, because it is a gauge of production. The report showed that the net export of goods and services declined in the first quarter by 3.2 per cent.

The headline figure belied ongoing strength in American household incomes. Personal consumption grew 2.7 per cent in the first quarter, up from 2.5 per cent at the end of last year.

That was nevertheless weaker than the forecast 3.5 per cent.

“The headline number looks a bit troubling and it came in weaker than expected. But when you dig beneath the surface, it largely painted a picture of resilient domestic demand in the first quarter,” said Kathy Bostjancic, chief US economist at Oxford Economics.

The data come as fears mount that inflation and aggressive tightening by the Federal Reserve will trigger an economic recession.

A widely used indicator of recession – the inversion of the yield curve – briefly flashed red earlier this month.

Following the report, Treasury yields across maturities rose, and an initial flattening of the yield curve was reversed. Trading in stock market futures was choppy, with both the S&P and Nasdaq contracts up more than 1 per cent going into the open.

Inflation

US growth is being threatened by the highest inflation in 40 years as the Russian invasion of Ukraine has driven up commodity prices and Covid lockdowns in China herald further supply chain issues.

There was further evidence of price pressures in the report: so-called core PCE, the Fed’s preferred measure of inflation which strips out the volatile food and energy sectors, rose 5.2 per cent, compared with 5 per cent last quarter.

The Fed has indicated that it will respond to inflation forcefully, with markets pricing in a half percentage point rate rise at its next meeting in May.

Investors in the futures market now expect the central bank to raise its key interest rate to 2.7 per cent by the end of the year, up from between 0.25 and 0.5 per cent today.

The full effects of inflation and tighter monetary policy have not yet translated into GDP.

A revision to how retail sales are calculated – announced by the census bureau on Monday – also curtailed growth in the first quarter, and is expected to bolster GDP in the second quarter. – Copyright The Financial Times Limited 2022