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MARKET TRENDS: First Quarter Advance GDP Estimate Lower Than Expected

May 13, 2016

In its advance estimate, the Labor Department announced that the U.S. Gross Domestic Product (GDP) increased at a 0.5% annual rate – the slowest since the first quarter of 2014. Economists had expected the economy to expand at a 0.7% pace after it displayed a 1.4% growth rate in the fourth quarter.

The main reasons behind the slowdown in economic growth were reduced levels of consumer spending and a strong dollar – which continued to undermine exports. In the first quarter of 2016, consumer spending (which constitutes more than two-thirds of U.S. economic activity), grew at just 1.9% – much lower than fourth quarter's 2.4% pace, and the least since the first quarter of 2015.

Low consumer spending, in turn, resulted in businesses placing fewer orders for goods. Although most organizations increased efforts to reduce an inventory bloat, inventory buildup nevertheless knocked off 0.33% point from first quarter GDP growth, compared to 0.22% in the fourth quarter.

Trade took away another 0.34% point from GDP growth, as an appreciating dollar led to reduced exports and increased imports. Between June 2014 and December 2015, the dollar gained 20% versus the currencies of the United States’ trading partners. The availability of cheap oil also hurt economic growth, with the result that business spending contracted at its fastest pace since the second quarter of 2009. Spending on non-residential structures declined at a 10.7% rate, while spending on mining exploration, wells and shafts tumbled at a record 86% pace.

Overall, almost all sectors of the economy deteriorated in the first quarter, the only exception being the housing market. In fact, according to the National Association of Realtors, the Pending Home Sales Index, a forward looking indicator based on contract signings, increased by 1.4% in March to 110.5, and is now 1.4% above March 2015. Contracts rose 3.2% in the Northeast from the prior month and were up 3.0% in the South. They increased by 0.2% in the Midwest, but declined 1.8% in the West.

Lawrence Yun, NAR chief economist, explained that these numbers indicate a solid beginning to the spring buying season. "Despite supply deficiencies in plenty of areas, contract activity was fairly strong in a majority of markets in March," he said. "This spring's surprisingly low mortgage rates are easing some of the affordability pressures potential buyers are experiencing and are taking away some of the sting from home prices that are still rising too fast and above wage growth."

Apart from housing, the jobs market also seems to be fairly robust. Applications for unemployment benefits hovered near a 43-year low, and employment gains averaged 209,000 jobs per month in the first quarter.

Nevertheless, given the backdrop of a sluggish economy and reduced consumer spending, the Federal Open Market Committee (FOMC) opted not to raise interest rates last month. At the end of its two-day meeting, the Fed kept the range steady between 0.25% – 0.50%, while indicating that economic activity appears to have slowed. In a statement, it said, “Growth in household spending has moderated, although households’ real income has risen at a solid rate and consumer sentiment remains high.”

The Fed last hiked its target rate a quarter point in December, the first such move in more than nine years. At that time, FOMC members had signaled that four hikes were probable this year. However after last meeting, it seems that only two more hikes can be expected this year. This is not surprising, given that the Fed has so far failed to meet its target of 2% inflation, despite maintaining its rate target near zero for eight years. In its statement, the FOMC once again repeated that inflation is being held back by “the transitory effects of declines in energy and import prices,” but is expected to rise toward 2% over the medium term.

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