GDP report indicates slow economic growth in the first quarter

The economy slowed sharply in the first quarter, despite a brisk bounce back in consumer spending. Even so, the 1.1% annualized growth pace was less than half the 2.6% advance in the final three months of 2022. It’s another signal that the economy is slowing, but also that the resilience of the nation’s consumers shouldn’t be underestimated.

Despite all the discussion of recession risk – which is very real – consumers remain willing and able to spend. Personal consumption increased at a 3.7% annualized clip, driven by a 6.5% increase in spending on goods – the first quarterly gain in goods spending since Q4 2021.

Consumer credit card debt has rebounded in recent quarters, in part fueling spending for lower-income households that have been hit particularly hard by rising housing and food costs. Meanwhile, household cash balances remain well above their pre-pandemic levels, providing an available reservoir of cash for middle- and upper-income households to increase their spending not only in nominal terms but also when adjusted for inflation.

That improvement came despite growing evidence that inflation is proving to be stickier than hoped. The core measure that excludes food and energy rose to 4.9% annualized in Q1, a half-point increase over the prior quarter. That’s a preferred measure watched closely by the Fed, making it a key consideration in their execution of monetary policy. The Fed has been warning for some time that even if they pause on further rate hikes, an outright reversal in rate policy in the near term is unlikely. The highest core PCE reading in a year isn’t likely to change their collective mindset.

The fact that consumption accelerated while measures of the consumer mood have deteriorated may suggest a divergence between attitude and activity. Whether or not that continues as the year progresses is a big question that will go a long way in determining how long the current expansion could be extended. Declining sentiment typically precedes some deterioration in future spending, so the erosion in confidence since the beginning of the year may still play out in the form of some retrenchment in discretionary spending over the next few quarters. A capitulation by consumers could represent the tipping point for the broader economy, making any data on consumption and retail activity important to monitor in the coming months.

Despite better consumer spending to start the year, the housing sector remained under pressure, having now contracted for eight consecutive quarters. Soaring prices and surging interest rates earlier in the cycle tell the story. If there’s good news, it’s that home prices have rolled over, and mortgage rates have likely peaked. Similarly, the pace of housing contraction eased considerably in Q1, suggesting that a bottom could be within sight.

Standing in stark contrast to the comparatively upbeat consumption results was a notable decline in business investment. Increasingly, it appears that fears of an impending recession are influencing capital budgets as corporate America battens down the proverbial hatches in preparation for the potential for greater weakness ahead.

Most notable was the sharp decline in business inventories, which alone shaved over two percentage points off Q1 growth. Manufacturing data confirms that production has been slowing in response to a reduction in incoming orders. That’s been exacerbated by businesses that, in some cases, have still been working toward right-size inventories and clearing out stock as global supply chains normalize.

The result was a mixed report – stronger for consumption, but weaker for business – that, in aggregate, keeps recession risk on the front burner of discussion while we wait for additional guidance from the Fed and closely monitor data looking for clues on the outlook for inflation and the labor markets conditions.

The bottom line? Recession risks remain elevated; the first estimate of Q1 GDP confirms that the economy continues to slow. It also serves as a poignant reminder of a key truism for the U.S. economy: don’t underestimate the power of the consumer sector. Continued negative momentum may eventually be enough for them to throw in the towel. For now, they’re doing the heavy lifting to keep the economy on track.