Weaker GDP growth based on a number of factors

GDP advanced at a respectable 3.1% annualized pace in Q4 but slowed considerably according to advanced data provided by the U.S. Commerce Department, growing just 1.8% in Q1.

Real final sales, which measures GDP less changes in private inventories, increased a scant 0.8%, versus a robust 6.7% in the final three months of 2010.

The table below looks at key components of GDP and how they contributed to or detracted from the economy last quarter and in Q4 per government data.

As an example, consumer spending contributed 2.8 percentage points to the 3.1% rise in GDP in Q4 and 1.9 percentage points in Q1. Weakness in other components translated into growth of just 1.8%.

	Q4’10	Q1’11
GDP	3.1	1.8
Consumer Spending	2.8	1.9
Change in Inventories	-3.42	0.93
Exports	1.06	0.64
Imports	2.21	-0.72
Govt. Spending	-0.34	-1.09
Residential construction	0.07	-0.09

The huge swing in inventories lent support to GDP in Q1, as companies lifted output following a big drawdown in Q4, but a large rise in imports detracted from overall economic performance.

Diminished consumer confidence and rising gasoline prices also appeared to pressure consumer spending despite the payroll tax cut that was enacted by Congress late last year.

Housing’s diminished role in the economy had very little impact (see Housing – losing its importance as economic driver).

Today’s report is not the final say on growth last quarter, as we have two more revisions that will incorporate updated information on trade, inventories and spending.

If there is a silver lining to today’s report, the outsized jump in imports played a key part in the feeble GDP number, but one can’t discount the anxiety consumers are feeling.

Needless to say, Q1 was a disappointment and is a stark reminder that a recovery that follows a recession caused by a financial crisis is typically slow and uneven.

Unfortunately, the uptick in weekly jobless claims and recent modest gains in the bond market suggest the slowdown is continuing into Q2.  Strength in the stock market, however, suggests the weakness we are seeing is temporary.

The consumer takes the reins of the recovery

Consumer spending lights up GDP

At first glance, the 3.2% annualized increase in GDP appears to be a disappointment since economists surveyed by a number of organizations had forecast 3.5%.

However, a steep decline in inventories, which detracted 3.7 percentage points from growth, masked what was otherwise a rather impressive report.


(supplied by the BEA)

Consumer spending accounted for 3 percentage points of the increase and rising exports added another full percentage point.  Real final sales, which excludes changes in inventory, grew a very robust 7.1%, the best gain since the second quarter of 1984!

Nonetheless, the Fed made it clear on Wednesday it remains unconvinced that the recent improvement in the economy will be enough to take a significant bite out of the jobless rate, and it sees no need to alter its plan to pump hundreds of billions of dollars into the economy.

Moreover, the advance data showed that core inflation rose at an annual rate of only 0.4% in the final quarter of the year, which is well below the Fed’s comfort zone of near 2%.

Labor costs, a key component in the inflation equation and something the Fed closely follows, haven’t changed much in recent quarters, so the argument from policymakers that rising prices won’t be an issue in the short term has some credence to it.


(supplied by the BLS)

Inflation could become a problem down the road, but that is not the Fed's immediate concern since it believes it can craft and implement an exit strategy before inflationary pressures build through the economy.

Looking ahead, any easing in already tight credit conditions could unleash more pent up demand, which would continue to boost output.  Plus, the contraction in inventories, which weighed on GDP, might actually fuel gains later in the year, as businesses re-stock shelves in order to meet both global and domestic demand.


(click to enlarge)

No doubt about it, headwinds remain, such as housing, sovereign debt worries in Europe and a reluctance among banks to lend, but the recovery is broadening and accelerating, which, if history is any guide (see chart and 30-year history above), should encourage companies to boost hiring.

Separately, a look at today’s advance GDP number is also available at Examiner.com.

Expanding GDP

The end of last week brought us another piece of good news, as the advance GDP report showed that the economy continues to expand.

Though not as robust as the 5.6% annualized increase in Q4 of last year, the 3.2% rise is encouraging given metrics that drove the the numbers. Unlike Q4's increase, which was fueled by a large rise in inventories, personal consumption spending jumped by the fastest pace in three years, confirming data out near the end of the quarter that showed consumer spending is accelerating.

Business spending also continued at a strong pace, while manufacturers continued to stockpile inventories, though not at the rate seen last quarter.

One week spot: new home construction detracted from growth.

Nonexistent inflation

As the recovery shows signs of deepening, inflation practically came to a halt outside of energy. The Fed's favorite gauge of prices, the core PCE Price Index, rose at an annual rate of just 0.6%.

Inflation is normally a lagging indicator and is probably at or near the bottom. But with prices barely rising, policymakers at the Fed have plenty of room to keep rates low without being overly concerned that inflation might heat up.

Surging GDP masks economic pitfalls

Friday's report on advance GDP showed that economic growth in the final quarter of 2009 jumped at its fastest pace in several years, surging at an annual pace of 5.7%. 4Q's increase is the second-straight rise in economic output following four consecutive quarterly declines.

By itself, the news is good given the deep economic recession that has caused the unemployment rate to spike past 10%. One piece of good news - capital spending posted a double-digit gain, suggesting companies are beginning to respond in a favorable way to the recovery.

But much of the rebound last quarter occurred as companies replenished dwindling stockpiles. Looking back over the past year, falling demand has been met sharp declines in production. This kept bloated inventory levels from soaring to untenable heights.

The painful cuts in production have brought inventories back to reasonable levels, and rising output accounted for 3.4 percentage points of the 5.7 point increase. But it seems implausible that 2Q will see the same level of growth if consumer spending does not noticeably pick up.

The Fed plans to end its purchases of government securities by the end of March, and fiscal stimulus may not provide the bang needed. Moreover, banks remain under pressure and have not loosened up on the purse strings in a way that might give the recovery the push needed to put it on a self-sustaining path.

I'm not expecting a double-dip recession, and the Leading Index and surveys of manufacturing are still suggesting further gains. But headwinds remains stiff and slow growth seems to be the most likely path.