U.S. economy likely shrank in first quarter, but fundamentals strong

May 29
8:10 AM 2015

The U.S. economy likely contracted in the first quarter as it buckled under the weight of unusually heavy snowfalls and a resurgent dollar, but activity since has rebounded modestly.

The government is expected to report on Friday that gross domestic product shrank at a 0.8 percent annual rate instead of growing at the 0.2 percent pace it estimated last month, according to a Reuters survey of economists.

A larger trade deficit and a smaller accumulation of inventories by businesses than previously thought will probably account for much of the expected downward revision.

With growth estimates so far for the second quarter around 2 percent, the economy appears poised for its worst first half performance since 2011.

Economists, however, caution against reading too much into the expected slump in output. They argue the GDP figure for the first quarter was held down by a confluence of temporary factors, including a problem with the model the government uses to smooth the data for seasonal fluctuations.

"The weakness in the U.S. recovery is not like a cart losing its wheels because the labor market remains healthy and housing activity is picking up," said Thomas Costerg, a U.S. economist at Standard Chartered Bank in New York.

Several economists, including those at the San Francisco Federal Reserve Bank, have cast doubts on the accuracy of GDP estimates for the first quarter, which have tended to show weakness over the last several years.

They argued the so-called seasonal adjustment is not fully stripping out seasonal patterns, leaving "residual" seasonality. The government said last week it was aware of the potential problem and was working to minimize it.

The Commerce Department will publish its first-quarter GDP revision on Friday at 8:30 a.m.


Apart from the statistical quirk, the economy, which expanded at a 2.2 percent pace in the fourth quarter, was hammered by labor disruptions at a major port. Also dragging on growth was a sharp decline in investment spending in the energy sector as companies such as Schlumberger (SLB.N) and Halliburton (HAL.N) responded to the plunge in crude oil prices.

"The cutback in oil investment was bigger than what people thought and the benefits through increased purchasing power for consumers have not materialized," said Harm Bandholz, chief U.S. economist at UniCredit Research in New York.

Economists estimate unusually heavy snowfalls in February chopped at least one percentage point from growth.

Trade was hit both by the strong dollar and the ports dispute, which weighed on exports through the quarter and then unleashed a flood of imports in March after it was resolved.

The GDP report is also expected to show a second quarterly drop in corporate profits because of the dollar and oil prices.

While the economy has pulled out of its first-quarter stall, data on retail sales and industrial production have suggested only a modest pace of growth early in the second quarter. But reports on housing, consumer confidence and business spending plans indicated momentum could be building.

Unlike 2014, when growth snapped backed quickly after a dismal first quarter, the dollar and investment cuts by energy companies continue to hamstring activity.

But growth could accelerate as the year progresses.

Inventory is likely to be revised down from the lofty $110.3 billion increase reported last month. That would suggest warehouses are not bulging with unwanted merchandise and that business have latitude to order more goods from factories.

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, could also finally get a lift from the considerable savings households amassed because of cheaper gasoline.

The dollar rally has faded and the greenback is about 4 percent off its peak in March, easing pressure on U.S. exporters. In addition, rig counts suggest the energy investment rout is nearing its end.

"As temporary factors fade in importance, fundamentals will reassert themselves," said Ben Herzon and economist at Macroeconomic Advisers in St. Louis, Missouri.

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