What the Fed Thinks of the Bleak GDP Report

What the Fed Thinks of the Bleak GDP Report
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What the Fed Thinks of the Bleak GDP Report

Going into today, market consensus was for U.S. Q1 GDP growth to come in at a seasonally adjusted annualized rate of just 1.0%. The 0.2% announced was much worse, with implications for the Federal Reserve’s intent to move off the zero bound for short-term interest rates.

Because data on inventories and trade flows are incomplete in the initial GDP release, it is more important to focus on the growth in real final sales to domestic purchasers, which strips out trade and inventories. But even after this adjustment, final domestic sales rose only 0.7%. Nonresidential investment fell −3.4% and equipment investment was flat. The savings rate increased, reaching 5.5% versus 4.6% in Q4. Consumption went up only 1.9%.

Markets may tend to look through the weak GDP number and infer that it was weather- and port-related – and a lot of it probably is. But capex has been weak now for six months, and exports growth has been negative for nine months.

To reach robust growth anywhere near 3%, the U.S. economy needs a boost to consumption and a fall in savings to offset the drag from exports and the collapse of oil investment. All eyes are now on the Q2 data flow, which commences next week with the May release of April data. Inventory investment rose in Q1, and to the extent this was unintended, it will be a drag on Q2 growth as the inventories are drawn down.

The statement released this afternoon by the Fed indicates that it plans to – hopes to? – look through this very soft patch of U.S. macro data. That said, the GDP data does add more weight to the Fed’s wait-and-see approach, which uses data flow to build the case for a fall 2015 hike. Markets – and the Fed – are projecting that 2015 plays out like 2014, when a soft Q1 GDP report was followed by a very strong rebound in Q2 and Q3. If that happens, it will bolster the Fed’s case to hike in the fall. If, however, economic growth does not play out according to consensus, we will all learn how data-dependent this Fed really is.

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