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Growth falls short in Q1

Inflation is going in the wrong direction.

Real GDP rose 1.1% in the first quarter, an underwhelming performance. It missed expectations for 1.9% growth and represents a sharp step down from the fourth quarter growth rate of 2.6%. Consumer spending was a bright spot and remained resilient in the face of rising interest rates and higher inflation. That came at a price. Core PCE inflation, the Fed’s preferred inflation measure, actually accelerated during the quarter, which means at least one more rate hike in May.

Consumer spending rose 3.7%, a pickup from the 1.0% pace in the fourth quarter. Goods consumption increased 6.5% in the first quarter while services spending rose 2.3%. In addition to strength in the labor market, where over one million new jobs were created, a record increase in Social Security payments provided a one-time bump to consumption. 

Residential investment continued to contract, -4.2%, but its performance was considerably less dire than the double-digit declines posted in the previous three quarters. The housing sector’s sensitivity to interest rates was apparent in the first quarter when mortgage rates fell back below 7%, spurring interest from buyers.

Business investment slowed considerably to 0.7% growth from 4% in the fourth quarter.  Equipment spending contracted 7.3% while intellectual property investment softened to 3.8%.  Spending on structures remained firm at 11.2% growth versus 15.8% in the fourth quarter, aided by spending on chip and electric vehicle plants.

Inventories were heavily liquidated in the first quarter as companies grappled with excessive inventories. That made a negative contribution of -2.3%, the largest drawdown in two years. As a result of the decline in goods production, the manufacturing sector likely entered contractionary territory at the start of the year as signaled by the Fed’s industrial production and purchasing managers’ index data. 

Any further rate hikes beyond May risk a deeper recession.

Government spending rose 4.7%, up from 3.8% in the fourth quarter. Nondefense federal spending jumped 10.3% after rising by 10.6% in the previous quarter, benefiting from the ramp-up in infrastructure expenditures. Defense rose 5.9% due to military spending. State and local government spending was more or less steady at 2.9% growth versus 2.6% growth in the fourth quarter.

The trade deficit narrowed as export growth outpaced imports. Exports were aided by a weaker dollar and a better performance in European economies due to a milder winter.

Inflation is going in the wrong direction for the Fed. The overall GDP deflator, an aggregate measure of inflation, rose 4.0% in the first quarter from 3.9% in the fourth quarter. The personal consumption expenditures (PCE) index, the Fed’s favored index, accelerated to 4.2% from 3.7%. More disappointment came from the core PCE index, which picked up to a higher 4.9% pace in the first quarter from 4.4%.  

Bottom Line

The strength in consumer spending for the quarter as a whole masks the sharp loss in spending power over the course of that time. Aside from the January jump in spending, boosted by Social Security payments, the imputed real PCE for March is -0.6%, to be released tomorrow. This would be the largest drop in consumer spending since December 2021 when consumers were impacted by Omicron. With the exception of January, consumption has contracted in four out of the last five months.  The Fed’s rate hikes are starting to bite.  Any further rate hikes beyond May risk a deeper recession than the mild downturn we currently foresee. 

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Meet our team

Image of Kenneth Kim
Kenneth Kim
Senior Economist, KPMG US

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