INDICATOR: First Quarter GDP

KEY DATA: GDP: +0.6%

IN A NUTSHELL:  “Despite the fact that the economy continued to crawl forward, everyone still thinks we are in a recession and they are behaving accordingly.”  

WHAT IT MEANS:  No negative growth yet.  The economy eked out a small increase in the first three months of the year, but let’s not get too excited about it.  There were few reasons to cheer the results.  The consumer spent money, but only on services such as medical care and utilities.  Meanwhile, sales of motor vehicles, furniture, food and gasoline were down.  The collapse in housing took a major toll on the economy and reduced overall GDP growth by 1.25 percentage points.  Businesses, uncertain about how steep the downturn would be and how long it would last, cut back on capital spending.  Firms managed to add to inventories, but I suspect that was not intended.  They probably got caught with goods that they couldn’t move and they may try to rid themselves of those excess stocks and slow production this quarter.  Excluding inventories, growth was negative.  On the positive side, exports were solid but a surprise rise in imports meant the trade deficit narrowed only modestly.  As for the government, we got a boost from defense spending but the growing fiscal crisis at the state and local level showed up in minimal spending growth there.  Despite the weak growth, disposable income, which is what people actually take home, actually rose quite solidly.  That kept the economy going.  On the inflation front, the government still seems to be the only group that doesn’t see things getting worse.  Indeed, the Personal Consumption Expenditure deflator, the index the Fed tends to follow the most closely, rose at a somewhat slower pace than at the end of last year.    

MARKETS AND FED POLICY IMPLICATIONS: We didn’t have a negative number and we might not actually wind up in a recession.  That might make equity investors happy and further support a pause by the Fed after a likely small cut later today.  But as I have said many times over the past few months, it is irrelevant whether this is a technically a recession as most individuals, businesses and governments think we are in a recession.  They are spending accordingly and this report will not change attitudes.  Lets’ call the two consecutive quarters of 0.6% GDP increases a growth recession even if it is not a full-fledged recession.  As for future growth, there are offsetting signal.  It is not likely we will have another 26.7% drop in residential construction and the trade deficit could narrow more dramatically.  Those are positives.  But we could see inventories drop and that would reduce growth.  However, the key to this quarter’s numbers is the consumer and what, if anything, they do with the rebates.  There will be some artificial increase in spending that results from the added funds but how much is unclear.  The additional spending, since it will be concentrated in the second and third quarters, will boost consumer demand.  The gain could offset any further cutbacks that might have occurred.  If households keep spending, even modestly, it is likely that growth in the second quarter will be positive as well.  But remember, once the money is gone, it is gone.  The rebates are a one shot deal and while they could be enough to keep us out of a technical recession, they don’t change the fundamentals of the economy.  Few firms will hire permanent workers on the basis of the rebate checks.  Thus, we could see a relapse once the government-induced sugar high disappears.