What Props Up First-Quarter U.S. Growth May Be a Drag Later

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The U.S. economy’s first quarter is looking a lot rosier than a few weeks ago, but the factors supporting that growth may be more ephemeral rather than a sign of sustained momentum.

That’s because rising inventories and a smaller-than-expected trade gap were among the main forces pushing up gross domestic product estimates for the first three months of 2019.

Thanks partly to those two volatile components, a Commerce Department report Friday is expected to show GDP expanded at a 2.3 percent annualized pace in the period -- up slightly from the fourth quarter and about in line with the 10-year average -- rather than the 1.5 percent seen in early March, according to Bloomberg’s surveys of economists.

What Props Up First-Quarter U.S. Growth May Be a Drag Later

“It’s a good news, bad news story,” said Richard Moody, chief economist at Regions Financial Corp. “If inventories are a big driver of growth in one quarter, then that sets you up for slower growth in subsequent quarters.”

Growth also likely got a lift from consumer spending -- the largest part of the economy -- after retail sales surged last month by the most since 2017. That eased some concern but expectations remain that consumers will pull back this year despite sustained wage gains and a tight labor market.

The more positive outlook is a shift in expectations from as recently as a week ago, when analysts saw several factors denting GDP, including the government shutdown that spanned most of January, extreme weather, and a trade war with China.

Some momentum may extend to the second quarter, with data Thursday showing a proxy for business-equipment orders rising the most in eight months, though unemployment filings jumped the most last week since late 2017.

The more upbeat news has coincided with U.S. stocks rising to a record this week and the Treasury yield curve moving away from an inversion that had signaled greater recession risk. While a brighter outlook would reduce arguments for a rate cut, the Federal Reserve has signaled it will keep borrowing costs unchanged this year amid subdued inflation -- plus, an unwinding of the inventories buildup is likely to drag down growth later in 2019.

What Bloomberg’s Economists Say

“While first-quarter GDP is likely to show a significant deceleration from last year’s pace, a second-quarter rebound will be stifled by a significant inventory reduction, thereby extending an impression of lukewarm economic growth through midyear. Bloomberg Economics projects first-quarter GDP growth below 2 percent, with inventory accumulation essentially mirroring the fourth quarter.”
--Carl Riccadonna and Yelena Shulyatyeva, economists

Fed officials at their policy meeting next week are expected to hold interest rates steady while making adjustments to their characterization of the economy to reflect the firmer data. The central bank won’t release quarterly projections until the following gathering in June.

Other headwinds remain, including residential and corporate spending that’s weakened after an initial tax cut-fueled boost in 2018. That helps explain why analysts are still skeptical that the U.S. expansion -- though on the verge of becoming the nation’s longest on record in July -- will still come short of President Donald Trump’s goal of a sustained 3 percent pace.

On the downside, factory production fell in the first quarter and business-equipment orders showed signs of cooling amid a dimming global growth outlook and trade-war uncertainty.

What Props Up First-Quarter U.S. Growth May Be a Drag Later

In addition, the Fed’s preferred price gauge, excluding food and energy, probably rose at a slower pace in the first quarter than the prior period, keeping inflation below its 2 percent objective.

“Though growth now looks a fair bit better than it did a month or two ago, it doesn’t necessarily mean the Fed is going to pivot back because they still want to see inflation,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. “The Fed will welcome the better growth, but I don’t think it’s going to really change much for them in the near future.”

A statistical quirk actually may argue in favor of growth picking up later in the year. The phenomenon known as residual seasonality has contributed to persistently lower GDP readings in the first quarter, something government statisticians are trying to remedy. The first quarter was the worst reading -- or tied for it -- in seven of the past 10 years.

What Props Up First-Quarter U.S. Growth May Be a Drag Later

Meanwhile, the housing market is showing signs of stabilization as lower borrowing costs attract buyers. New home sales climbed at the fastest pace since 2017 in March, while applications for home loans recently rose to the highest weekly level in almost nine years.

“Recent data put some of people’s more-extreme fears about recession to rest,” said Brett Ryan, senior U.S. economist at Deutsche Bank AG. “Despite all these disruptions -- the government shutdown, polar vortex, bomb cyclone in the Midwest -- things weren’t that bad.”

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