U.S. First-Quarter Growth Revised Up Slightly

The revision has moved growth a bit further into positive territory, and the better balance between final sales and inventories reduces the likelihood of a sharp inventory correction in the second quarter. But we should be careful about jumping to the conclusion that the second quarter will be dramatically better than previously thought. Note that both imports and inventories were revised down in the first quarter, and the two are probably related. The better balance of sales and inventories may cause a smaller inventory adjustment in the second quarter than first thought (a plus for GDP growth), but it might also mean more imports (a negative). At present, we still see growth in the second quarter as slightly negative, although it is becoming a closer call—we may eke out another small plus.

But the report hardly portrays a healthy economy, because it still shows domestic final sales down, by 0.1%, the first such decline since the fourth quarter of 1991. Housing activity is still plunging, and real consumption growth slowed to 1.0%. Growth should improve in the third quarter, helped by stimulus payments, but then weaken again in the fourth, as we expect the housing downturn, the credit crunch, and high commodity prices to continue to weigh down the consumer.

Foreign trade remains a huge support for growth. Trade added 0.8 percentage point to first-quarter growth, but that support came not from strong export growth but from declining imports. Essentially, the United States passed on more of its domestic demand weakness to the rest of the world than first thought. The downward revision in export growth is troubling (goods exports rose just 1.5%). If export growth were to stay soft, we can't count on slashing imports each quarter to support domestic production. But since the signals on export orders from recent ISM surveys and from April's durable goods report are good, we think that export growth will bounce back.

Inflation indicators in the report were little changed from the original report. The core personal consumption price index rose 2.1% at an annual rate, a little better than the 2.2% initially announced, but this will be little comfort to the Federal Reserve as it contemplates the risk that rising commodity costs, especially for energy, will pass into the core rate in the future. The interest rate cuts that we had anticipated for later in the year, based on a weak growth outlook, are now looking unlikely, given the mounting inflation risks. But we do not expect the Fed to raise rates this year.

The report also gave the first estimate of profits for the first quarter. Pre-tax profits from current production were still in positive territory, up 1.7% year-on-year, but this reflects strength abroad and currency translation gains, rather than strength at home. Profits earned at home were down 5.3%, while profits earned overseas were up 18.8%.

Both the GDP report and the profits report emphasize just how important foreign demand has been—and will continue to be—in limiting the extent of the slowdown in the U.S. economy.