We cut our U.S. economic forecast this week, not solely because of the Q1 contraction, but because of the gathering clouds on the horizon. Front and centre is stubbornly high inflation and the Fed’s looming fight to tame it. Close behind is the uncertain outcome of the war in Ukraine and the extended lockdown in China, both of which are further snarling global supply chains. We carved our GDP growth outlook by half a percentage point to 2.5% this year and to 1.7% next year. The keen reader will note that the latter is below potential, meaning the unemployment rate will likely turn higher next year after quite possibly breaching seven-decade lows of 3.3% later this year. A moderate upturn would still qualify as a soft landing, assuming the Fed can pull it off.
The Q1 release was indeed disappointing, but it was far from a disaster. There were several extenuating circumstances that masked underlying strength. The 1.4% annualized decline only offset a portion of the prior quarter’s 6.9% surge, resulting in a respectable 2.7% average advance in the two quarters. It also largely stemmed from a surge in imports, which is less bad when domestic supplies are hard to find, inventories need replenishing, and production has to catch up with demand. As well, it was greased by a sharp decline in government spending, including defense, which isn’t likely to be repeated. Most importantly, accelerating business investment and sturdy consumer spending lifted private domestic demand by a solid 3.7% annualized, the most in three quarters.
No doubt the economy will downshift this year in response to tighter monetary and fiscal policies. But it should avoid a recession. Domestic demand remains resilient partly because many households are tapping into a trove of excess savings accumulated during the pandemic worth about $2.4 trillion or 13% of disposable income. And because consumers are still spending, businesses are investing and hiring. Even as the negative GDP print hit the wires, timelier data showed initial jobless claims fell to 180,000, still trending near the lowest levels since 1969. Few companies are laying off workers when they still have more than 11 million job vacancies to fill. Real GDP is expected to rebound 2.6% in Q2. It will moderate in future quarters as the Fed tightens the reins. But conditions will need to get worse before the expansion truly reverses course.