Economy contracts 1.4% in the first quarter in first drop since 2020

An earlier version of this story inadvertently mischaracterized the direction of GDP.

After a blockbuster 2021, the U.S. economy decidedly came back to earth early this year, contracting for the first time since the second quarter of 2020.

The trade deficit widened and companies pulled back stockpiling, more than offsetting solid consumer spending and business investment. 

The nation’s gross domestic product, the value of all goods and services produced in the U.S., shrank at a seasonally adjusted annual rate of 1.4% in the January-March period, the Commerce Department said Thursday. Economists surveyed by Bloomberg had forecast a 1% rise in GDP.

It marks the economy’s worst quarterly showing since the depths of the health crisis in spring 2020 and follows sizzling gains of 6.9% in the fourth quarter and 5.7% for all of last year. That was the strongest annual rise since 1984.

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But it doesn’t mean the economy is in a recession, though the odds of a slump already had risen to 20% to 30% over the next 12 months from 15% in 2021, top economists say.

A drop in quarterly output – or even two in a row – doesn’t equate to a downturn. Rather, the National Bureau of Economic Research defines a recession based on a significant decline in economic activity, including employment, retail sales and industrial production.

U.S. consumers and businesses – the core of the economy – remain healthy.

“While the possibility of a 2023 recession can’t be ruled out, current economic momentum in the economy remains too strong for things to suddenly sputter out,” economist Thomas Feltmate of TD Economics wrote in a note to clients.

Inflation eases but remains high

Growth should still be sturdy, if markedly slower, in 2022. But Thursday’s report kicks off an uncertain year for the economy as inflation eases but remains elevated and the Federal Reserve wages an aggressive campaign to fight it with interest rate hikes that could risk a downturn.

In the first quarter, trade accounted for the dismal performance, subtracting more than 3 percentage points from growth.

Exports fell 5.9% as U.S. manufacturers continued to grapple with supply snarls, and foreign countries struggled with COVID-19 flare-ups.

Meanwhile, imports surged 17.7% as a result of American consumers who continued to snap up goods. The combination widened the trade gap.

Also, firms added to inventories more slowly, trimming nearly a percentage point from growth

Companies bulked up their inventories late last year after drawing them down earlier in response to late deliveries. But they replenished stockpiles so aggressively – adding more than 5 percentage points to GDP growth – that there was bound to be a pullback in the first quarter, says economist Ian Shepherdson of Pantheon Macroeconomics.

Consumer spending, which makes up 70% of economic activity, grew 2.7% following a 2.5% rise late last year. Those are decent numbers, but they pale next to the double-digit advances of early 2021 when the economy was reopening and federal stimulus checks juiced purchases.   

On the one hand, the nation continued to heal from COVID-19 in recent months as cases tumbled after January’s omicron surge, leading many Americans to resume shopping, traveling and dining out. That has partly made up for a cutback in consumers’ spending binges on sofas, TVs and other goods while they hunkered down during the pandemic.

Households also have been bolstered by robust job and wage growth as employers struggle to fill a near-record number of openings. Many people are still out of the labor force – meaning they’re not working or looking for jobs – for COVID-19-related reasons.

But inflation hit a 40-year high of 8.6% in March and the spike in gasoline, food and rent costs has led many households to curtail their discretionary purchases, says Wells Fargo economist Sam Bullard.

Supply chain untangles, but Ukraine and China pose challenges

The supply chain bottlenecks that helped fuel the soaring prices are starting to ease and many economists believe inflation has peaked. But Russia’s war in Ukraine and COVID-19-related lockdowns in China pose new threats to the shipment of goods across the globe.

Bullard expects the economy to grow 2.8% this year, a healthy showing in relation to the pre-pandemic era, but a big downshift from last year’s leap in output.

And the Fed has vowed to bring down inflation with sharp interest rate hikes, raising concerns about whether the central bank can slow the price increases without triggering a recession. Pearce predicted the first-quarter drop in GDP would not keep the Fed from hiking rates by half a percentage point at a meeting next week.

How other parts of the economy performed:

Business investment rebounds

Business capital spending grew a healthy 9.2% after a 2.9% gain in the third fourth quarter.

Outlays for computers, delivery trucks, factory machines and other equipment jumped 15.3%. Supply chain snags are easing, spurring businesses to order more vehicles and other equipment that had been in short supply. And persistent w shortages are leading companies to buy more labor-saving technology, says economist Michael Pearce of Capital Economics.

But spending on buildings, oil rigs and other structures edged down 0.9% after an 8.3% decline late last year. Intellectual property spending rose 8.1%, notching strong results for the seventh straight quarter.

Residential investment rises

Housing construction and renovation rose a modest 2.1% following a 2.2% gain the previous quarter.

The industry is facing hurdles such as rising prices and interest rates, along with supply chain problems that have slowed deliveries of materials and pushed up prices.

But low housing inventories mean builders need to put up more homes, and the improving health crisis is coaxing construction workers back to job sites, says economist Shernette McLeod of TD Economics.

Government spending falls

Government spending slid 2.7% after a 2.6% drop the prior quarter. Federal spending declined 5.9% while state and local spending dipped 0.8%.

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