Real GDP contracted 1.4% in the first quarter after jumping nearly 7% in the fourth quarter. The good news is that the domestic economy held up much better than those figures suggest.
Gains in consumer spending, the housing market and business investment, the three pillars of the private sector, added 3.2% to growth in the first quarter. That is actually up from the 2.4% contribution of the fourth quarter. Yes, you read that correctly. The most important aspects of the domestic economy held up better than they did at the end of 2021, when growth was soaring.
Robust employment gains (a stunning 1.7 million jobs in the first quarter alone) and the savings and wealth amassed during the pandemic enabled consumers to continue spending, despite the surge in prices at the gas pump. Housing held up with all-cash buyers further crowding out first-time buyers. A temporary easing of backlogs enabled businesses to move forward on spending delayed in 2021; the acceleration in business investment is the primary reason for the increase in domestic spending.
The bad news is where the weakness was: inventory accumulation slowed despite ongoing shortages; government spending contracted even faster than we saw in the fourth quarter when much of the pandemic aid lapsed; the trade deficit blew up. Exports fell at their fastest pace since early in the pandemic when the entire world was suffering lockdowns, while imports continue flooding in at a double-digit pace.
The story is fairly straight-forward. The Omicron wave, the war in Ukraine and new lockdowns in China took a greater toll on growth abroad than at home.
The ugly is inflation, which soared to its fastest pace in four decades. That has prompted the Federal Reserve to embark on what could be the most rapid tightening of credit market conditions since the 1980s. The Fed doesn’t have a long history of fighting inflation without derailing overall growth. The 1994 example represented a preemptive move on inflation and was more, to use Chairman Powell’s words, “soft-ish” than soft.
The weakness in the first quarter was more reflective of weakness abroad than weakness at home. That resilience has spurred inflation and left the Fed scrambling to raise rates. The challenge will be for the Fed to cool domestic demand without sending too much of a chill through the labor market. Getting policy “just right” is no easy feat. Goldilocks only exists in fairy tales.
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