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Economic Insights

A buildup in inventories may signal that current U.S. growth is being borrowed from future quarters.

 

In Brief

  • The first estimate of U.S. gross domestic product (GDP) growth in the first quarter of 2019 was 3.2%, above the upwardly revised 2.3% consensus forecast.
  • U.S. economic growth was boosted by a surprisingly positive contribution from inventory change. We believe this likely will turn into a drag on GDP growth in coming quarters.
  • If the current GDP estimate holds up, it will feed into the acceleration in productivity growth that has become evident in recent quarters. For the U.S. economy and risk assets, we think that’s a very good thing.

 

In a reversal from the pattern of previous years, the U.S. Commerce Department’s report on U.S. gross domestic product growth for the first quarter of 2019 contained a significant upside surprise. Growth accelerated from 2.2% in in the fourth quarter of 2018 to 3.2% in the first quarter of 2019, above an upwardly revised consensus forecast of 2.3% (according to Bloomberg data). The increase in the headline number came despite a deceleration in domestic final demand—consumer spending, private fixed investment, and government spending—from 2.0% to only 1.2%.

How did it happen? A surprisingly positive contribution from net exports and inventory change were behind the acceleration in growth, and will likely cause a slowdown in the rest of 2019. Net exports contributed 1.3% to GDP growth in the first quarter as exports increased by a modest 3.7% while imports contracted by 3.7%. Both are consistent with a global trade slowdown.

Historical data tell us that falling imports lead to lower inventories of imported goods. This would normally offset some of the positive contribution from net exports. Instead, inventory change added 0.7% to growth in the first quarter. As a result, the combination of the two added 2.0% to GDP growth. As shown in the table below, that’s unusually large.

Note that in the second and third quarters of 2018 there were large swings in the same two factors, but they wound up offsetting each other.

Inventories are now growing much faster than final sales, a condition that inevitably leads to a slowdown because it means that supply is growing faster than demand. The same condition held in the second half of 2018. The persistent imbalance will need to be unwound over the course of the next few quarters.

Other notable details of the 2019 first-quarter GDP report:

  • Consumer spending only grew by 1.2% due to a sharp slowdown in durable goods purchases (vehicles). Based on recent data reports, spending is accelerating in the second quarter of 2019.
  • Spending on intellectual property—research and development, software, and media—increased 8.6% and sustained positive growth in business fixed investment. These types of expenditures are much less cyclical than nonresidential construction or equipment spending.
  • Residential construction dropped for the fifth consecutive quarter as the shift to multi-family housing continued depressing overall spending.
  • State and local government spending accelerated to 3.9% after a weak fourth quarter of 2018 and offset a continued federal fiscal drag from sharply declining nondefense spending (an overhang of the partial government shutdown during the 2019 first quarter that we expect will reverse in the second quarter).

One Final Note: The Productivity Picture
Another important takeaway from the first-quarter GDP report: Aggregate hours worked rose 1.9% on a seasonally adjusted annual rate, implying that productivity growth was close to 1.5%. If so, productivity growth will have risen at an average 2.0% pace over the past year, the best performance in the current recovery and a very unusual event in a late-cycle environment.

Rising productivity can create an economic “sweet spot” in which a rising standard of living, low inflation, and high margins can comfortably coexist. (Be sure to tune in to our upcoming podcast and video for a deeper dive on wages and productivity, and their economic impact.) Even if this doesn’t last forever, we believe this development provides fuel for further gains in U.S. risk assets.

 

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