Q1 GDP Smashes Expectations, Soars 3.2%, But The Real Story Is Below The Surface

With the Atlanta Fed forecasting Q1 GDP of as little as 0.5% about 6 weeks ago, traders were shocked when moments ago the BEA reported a GDP print that at first glance many though was a misprint: at 3.2%, Q1 GDP came in 50% higher than the 2.3% expected, and was the highest Q1 GDP (which is not only the weakest quarter of the year, but also a quarter notorious for its residual seasonality) since 2015.

That was the great news: the not so great news - the number was driven entirely by "one-time items" such as a surge in inventories and a far smaller trade deficit, pushing net trade sharply higher, neither of which is sustainable; meanwhile the core drivers of GDP - consumption and fixed investment - came in somewhat weak, dropping from Q4, with PCE and CapEx adding just 1.1%, or about a third, of the bottom line GDP number.

The breakdown of contribution to the bottom line GDP was as follows:

  • Personal Consumption: 0.82%
  • Fixed Investment: 0.27%
  • Change in inventories: 0.65%
  • Net Trade: 1.03%
  • Government consumption: 0.41%

And visually:

And here again is why one should always read the internals: this was the weakest quarter for household spending in five years.

Some more details from the report: the increase in real GDP reflected increases in consumer spending, inventory investment, exports, government spending, and business investment that were partly offset by a decrease in housing investment. Imports, which are a subtraction in the calculation of GDP, decreased in the first quarter.

The increase in consumer spending reflected an increase in services (led by health care) that was partly offset by a decrease in goods, specifically motor vehicles and parts. The increase in inventory investment reflected an increase in manufacturing inventories, notably non-durable goods. The increase in exports reflected increases in exports of both goods and services. Additionally, the report noted that the increase in government spending reflected an upturn in state and local government spending, notably investment in structures.

Meanwhile, the Fed is trapped because while on one hand the economy is growing at a torrid pace, at the same time the BEA reported that Core PCE rose at just 1.3%, below the 1.4% expected, and sharply lower from 1.8% last quarter. In total, prices of goods and services increased 0.8% in Q1, after rising 1.7% in the fourth quarter of 2018. Food prices increased 3.0 percent, while energy prices decreased 16.7% in the first quarter.

While it remains unclear if the Fed will resume hiking rates, according to Natalliance Securities, the GDP data squashes the idea of any Rate Cuts. Specifically, the analysts notes that Q1 growth at over 3% shows the economy is growing at a solid pace and makes clear the Federal Reserve won’t have any reason to cut rates this year as some traders are pricing in, according to Andrew Brenner, the head of international fixed income at Natalliance Securities in New York.

“You are seeing a strong enough economy with low inflation and the talk of precautionary rate cuts are way to early and not relevant,” Brenner told Bloomberg, adding that the weaker-than-expected PCE won’t be sufficient to trigger the Fed to reduce rates given growth is over 3 percent and unemployment at below 4 percent. "That is not a formula for the Fed to ease."

In other words, Powell will have to explain how he is balancing the blistering economic growth on one hand, and the continued slide in "official" inflation.