Another disappointing GDP report

GDP growth in the first quarter fell short of expectations, with a 2.5 percent annualized increase (consensus had expected 3 percent growth or more). This is roughly in line with the economy’s potential growth rate, and not strong enough to “catch up” the ground that was lost during the recession, either in terms of reducing unemployment, or vacancies in offices, retail stores and other commercial buildings.

Economic growth was weighed down by continued cutbacks in federal defense spending, state and local government budgets, and paltry economic growth in Europe and other global trading partners. Private domestic demand—that is, spending and investment by U.S. households and businesses—posted a robust 3.8 percent rate of growth.

There are two important engines of growth that we expect to contribute to the economy’s momentum in the months ahead:

  • The housing recovery is adding directly to GDP growth, with a 12.6 percent rise in residential investment. The indirect effects on the economy are likely even more important, including household purchases of appliances and furniture, rising home values helping heal household balance sheets, and bolstering consumer confidence.
  • The job market provided good news in the GDP report. Yes, you read that correctly; rising wages and salaries are making a more positive contribution to household incomes. In particular, wages and salaries have risen at an annualized 3.7 percent growth rate over the past half-year, nearly twice the 1.9 percent increase over the prior six months. This stronger income growth provided critical support to the 3.2 percent growth in consumer spending, the best since 2010.

The Bottom line: GDP growth fell short of expectations due to further cuts in government spending and struggling growth in Europe and other trading partners. U.S. households and businesses, however, continue to gain ground. We expect the gathering momentum in private domestic demand will contribute to more consistent headline GDP growth later this year and next.

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