U.S. economy contracts in first quarter; dollar hurts corporate profits

By Lucia Mutikani

WASHINGTON (Reuters) – The U.S. economy contracted in the first quarter as it buckled under the weight of unusually heavy snowfalls, a resurgent dollar and disruptions at West Coast ports, but activity already has rebounded modestly.

The government on Friday slashed its gross domestic product estimate to show GDP shrinking at a 0.7 percent annual rate instead of the 0.2 percent growth pace it estimated last month.

A larger trade deficit and a smaller accumulation of inventories by businesses than previously thought accounted for much of the downward revision. There was also a modest downward revision to consumer spending.

With growth estimates for the second quarter currently around 2 percent, the economy appears poised for its worst first-half performance since 2011. The economy’s recovery from the 2007-2009 financial crisis has been erratic.

Weak data on consumer sentiment and factory activity in the Midwest on Friday suggested that while the economy has pulled out of its first-quarter soft patch, the growth pace was modest early in the second quarter. That mirrored other recent soft data on retail sales and industrial production.

But reports on housing and business spending plans have indicated momentum could be building, which would keep the Federal Reserve on track to raise interest rates later this year.

Economists caution against reading too much into the 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.

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.

“Obviously the economy is weaker than we would like it to be, but the first quarter overstates that,” said Robert Dye, chief economist at Comerica in Dallas. “We’re going see enough growth to keep job creation in place and allow the Fed to maintain their lift-off schedule for September.”

When measured from the income side, the economy expanded at a 1.4 percent rate in the first quarter. A measure of domestic demand growth was revised up slightly and business spending on equipment was much stronger than previously estimated, taking some edge off the slump in output.

U.S. Treasuries were trading higher, while the dollar was largely unchanged against a basket of currencies. Stocks on Wall Street fell.

DOLLAR, ENERGY DRAG

Apart from the statistical quirk, the economy, which expanded at a 2.2 percent pace in the fourth quarter, was hammered by 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.

Spending on mining exploration, shafts and wells plunged at a 48.6 percent pace in the first quarter, the largest drop since the second quarter of 2009.

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 labor dispute, which weighed on exports through the quarter and then unleashed a flood of imports in March after it was resolved.

That resulted in a trade deficit that subtracted 1.90 percentage points from GDP, the largest drag in 31 years, instead of the 1.25 percentage points reported last month.

The GDP report also showed after-tax corporate profits declined 8.7 percent. That was the largest drop in a year and the second quarterly fall, as the strong dollar burdened multinational corporations and oil prices hurt domestic firms.

Multinationals like Microsoft Corp <MSFT.O>, household products maker Procter & Gamble Co <PG.N> and healthcare conglomerate Johnson & Johnson <JNJ.N> have warned the dollar will hit sales and profits this year.

Unlike 2014, when growth snapped back 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.

The value of inventory accumulated in the first quarter was revised down to an increase of $95 billion from the lofty $110.3 billion rise reported last month.

That meant inventories contributed 0.33 percentage point to GDP instead of the previously reported 0.74 percentage point, suggesting warehouses are not bulging with unwanted merchandise and businesses have latitude to order more goods from factories.

While consumer spending, which accounts for more than two-thirds of U.S. economic activity, was revised down by one-tenth of a percentage point to a 1.8 percent rate, it could finally get a lift from the considerable savings households amassed because of cheaper gasoline.

Personal savings increased at a robust $726.4 billion pace.

“The outlook for the economy is very encouraging,” said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.

(Reporting by Lucia Mutikani; Editing by Paul Simao)

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