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Economic Insights

A flat first quarter likely will be followed by one or two quarters of accelerated growth. Then it’s back to the muddle. 

Economic growth seems to have all but stopped during the first quarter. Preliminary Commerce Department figures on real gross domestic product (GDP) show only a 0.2% annual rate of expansion.1 Even though much that held the quarter back was temporary, this news will surely scotch the widespread talk of an acceleration in the recovery that cropped up around the strong second- and third-quarter reports last year. Such an acceleration, however, was never likely, because all that has kept this recovery substandard to date remains in place. But for those who like to talk about accelerations, the news in the second and possibly third quarters this year likely will provide ammunition. Some catch-up will almost surely occur as the weights holding down the first quarter lift. But if the recently reported weakness overstates the downside, the likely future surge will overstate on the high side. A continued, slow recovery will almost surely prevail.

How the Quarter Looked  
Four temporary factors conspired to depress economic activity during the quarter just passed: 1) a prolonged dock strike on the West Coast did more to slow flows of exports than imports; 2) dollar strength buoyed imports, while also constraining exports; 3) the consumer, distrusting the durability of low oil prices, saved rather than spent the spare income that accrued from reduced fuel costs; and 4) unusually severe winter weather contributed to slow consumer spending and especially constrained construction activity. To some extent, this is a rerun of last year’s experience, and just like last year, a catch-up will likely follow. If these new weather patterns hold, they eventually will be reflected in the Commerce Department’s seasonal adjustment procedures, but it is too early for that.    

Evidence of all this is clear in the Commerce Department report. Exports during the first quarter fell a steep 7.2% at an annual rate. To some extent, this weakness reflects the dollar’s building strength. Dollar appreciation had already begun to slow exports growth last year, which grew at an annual rate of only 4.5% during the fourth quarter of 2014, well down from the 11.1% pace recorded last spring. The dock strike, however, was likely a much bigger factor. The suddenness of the drop alone testifies to its overriding influence. Currency effects typically unfold gradually. Also pointing to the strike, goods exports accounted for more than the overall drop; they fell at a 13.3% annual rate. Service exports—which have need for neither ships nor longshoremen—grew a healthy 7.3% in the first quarter. A buildup in inventories, of those products that could not be loaded during the strike, mitigated the effect on the overall GDP, but did not offset it.   

Meanwhile, the household sector, some 70% of the economy, curtailed its spending during the quarter. Overall consumer outlays increased at an annual rate of only 1.9%, far slower than the 3.9% rate averaged during the prior three quarters or the 4.0% expansion in household income recorded for this year’s first quarter. The slow pace of spending is even more remarkable given that low fuel prices freed up monies for other sorts of spending. Outlays so trailed income growth that household savings rates jumped from 4.6% of aftertax income during last year’s final quarter to 5.5% during the quarter just passed. Had consumers believed that the savings on fuel would last, they no doubt would have spent more freely. Had they just kept up with overall income growth and spent only half of what they saved on fuel, real GDP growth would have approached 2.0% in the first quarter.  

In addition to this source of consumer restraint, cold and stormy weather in the opening months of the year likely held back spending as well. The biggest impact of weather, however, fell less on the consumer than on construction spending. In the residential space, growth slowed from a 5.3% average annual pace in the prior three quarters to only 1.3% during this year’s first quarter. Weather effects had an even greater impact on commercial construction, which fell at a striking 23.1% annual rate during the first quarter, a sharp drop from the 7.8% average annual pace of advance during the prior three quarters and far worse than the slow, but still positive 2.9% annualized growth rate recorded during last year’s weather-oppressed first quarter. Surely there is more at work here than weather, but the latter played a significant role.

Going Forward, Bounce Is Likely  
If this picture of weakness overdraws the underlying state of the economy, it nonetheless also sets the stage for a spring bounce. Contributing directly to such a turn is the end of the dock strike. To be sure, renewed activity at West Coast ports will allow in a greater flow of imports, but it will have a disproportionately greater impact on exports, whereby manufacturers, mining firms, and shippers will strive to make good on orders that the work stoppage prevented them from filling in the past few months. If exports simply recoup the ground they lost during the winter quarter, even without the least net expansion, this sector would add 1.25 percentage points to the overall growth pace of real GDP in the spring quarter. The dollar, of course, is still strong, leaving reason to expect slow growth at best beyond such a catch-up, but the pace of dollar appreciation has moderated, offering some reason to expect only a moderate further deterioration in the country’s trade balance.      

Making its own pleasant contribution to a turn is the indisputable fact that spring has arrived. The warm weather has lifted the weight on the construction sector that was clearly in evidence last January, February, and March. Even if there were no attempt to make up for ground lost during the past three months, and commercial as well as residential construction simply resume their former, relatively moderate pace of advance, the spring and summer quarters could enjoy an additional percentage point of overall real growth or more. Indeed, monthly data indicate that such a turn may already be in process. By March (the most recent month for which overall construction data are available), the situation appeared to have stabilized. March data on new housing starts showed a modest 2.0% uptick from February. Though little data are available as yet on commercial construction, a 3.5% March upturn in non-defense capital goods orders, after many months of net declines, speaks to a greater willingness by business to spend.

Consumer spending too will almost surely respond positively to the warmer weather. Retail sales were, in fact, already on an upswing in March, showing a 0.9% jump over February levels, over 11.0% at an annual rate. That pace is not likely to continue, but it puts spending levels at the beginning of the second quarter already well above the first-quarter average. If households simply keep spending up with recent income growth, the consumer will add an additional 0.7 percentage points to the overall pace of real GDP growth from the first quarter showing. And then there is the question of oil prices. The drop in fuel prices during the second half of 2014 effectively added some 4.0% to households’ real disposable income. Though they saved just about all of it, persistently lower fuel prices could increase household confidence that this relief will last and so also encourage them to spend more of the monies freed up by lower fuel bills. They might be that much more willing to spend because they have already raised their rate of savings. There is, of course, no telling if they will respond in this way and, if they do, by how much. But the potential clearly exists for a surprise on the high side.

A Warning
The stage, then, is set for overall real GDP growth of more than 3.0% during the second and possibly the third quarter. If the statistical stars line up right, one or the other of these quarterly reports could show significantly more growth. Doubtless such news could rejuvenate once-popular forecasts of an acceleration in the recovery. That is what happened last year. Such a view would, however, likely mislead as much as it did last year and as much as the picture of weakness in first quarter has created some fears about future growth. This recovery has remained fundamentally slow, and likely will continue to proceed that way (for reasons covered at other times in this space, and too involved to examine here now). Just as last year, the net of all the quarter-to-quarter ups and downs should average close to a slow annual real growth pace of near 2.5%. 

 

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