Q1 GDP revised modestly higher to 1.3%

Updated data released by the Department of Commerce today confirmed that the pace of growth slowed sharply in the first quarter following a strong second half last year but not to the degree previously reported. The second estimate for Q1 GDP was raised to a 1.3% annualized advance, modestly better than economists had expected.

Personal consumption was the key driver behind the advance, expanding at a crisp 3.8% pace. Spending increased for both goods and services, boosted by a surge in auto purchases that alone accounted for about 40% of the quarterly growth in consumption. Consumer spending has benefited from the strength of the labor markets, solid wage gains, and a pile of cash accumulated since 2020. Debt service as a percentage of disposable income has fallen to multidecade lows, providing additional budget leeway for discretionary spending.

Of course, it’s inappropriate to paint all households with the same broad brush, as lower-income Americans have felt the impact of rising prices to a greater degree. Sharp increases in food and housing costs are disproportionally weighing on lower-income households, which likely account for a meaningful portion of the uptick in consumer credit in the past year.

The story isn’t universally positive for consumers though. The high cost of housing and a spike in mortgage rates continues to weigh on residential construction. Housing was a drag for the eighth consecutive quarter in Q1, although the pace of contraction slowed. The contribution to GDP by housing pales in comparison to spending on other goods and services, limiting its impact on overall growth. Still, a weak housing market can be a sign of things to come for consumers, who may have to tighten their spending belts further as the full effect of Fed interest rate hikes moves beyond housing and continues to permeate the economy.

A decline in business inventories during the quarter created a sizable drag, shaving over two percentage points off top-line growth. The flow of goods and business inventory levels have been particularly choppy in recent years, as global supply chains have unkinked and businesses have tried to normalize their stock levels. A reduction in inventories imply that the pace of production slowed and stocks were chewed down by consumer demand. Whether or not inventory decumulation will remain a headwind to growth in the coming quarter may hinge on businesses’ collective assessments of consumer demand. Recession concerns are real and growing, leaving many businesses undoubtedly hesitant to stock up aggressively in the face of potentially waning demand. Of course, that could change if demand remains solid and the Fed is somehow able to navigate the economy to a soft landing. In the latter scenario, an inventory rebuild cycle could provide another tailwind for growth.

On a more ominous note, gross domestic income (GDI) contracted for the second consecutive quarter and the third time in the past year. Inflation remains high and continues to corrode spending power. Over time, GDI and GDP are expected to track one another fairly closely but can experience periods of dispersion. The fact that GDP has been able to grow in recent quarters despite negative real income growth also points to Americans tapping into their savings stockpile to fuel spending. That can provide a lift for some time, but consumers will eventually begin to pare back to maintain their reserves.

The bottom line? There was very little in the updated Q1 GDP numbers that wasn’t already known. Consumers — the critical lynchpin to the U.S. economy — are still spending, tapping into savings and credit to be able to do so. That can’t persist indefinitely though — raising the risk of a more pronounced slowdown or recession, the longer the Fed’s battle with inflation drags on.

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