US economy is contracting for the first time since mid-2020

The U.S. economy fell unexpectedly in the first quarter as a record high trade imbalance and weaker inventory growth masked strong spending by U.S. consumers and businesses.

The U.S. Department of Commerce reported that gross domestic product fell 1.4 percent year-on-year in the first quarter, a dramatic drop from the 6.9 percent increase recorded in the fourth quarter of 2021.

It marks the first contraction of the economy since mid-2020, when Covid-19 lockdowns had limited activity. The data corresponds to a decrease of 0.4 percent compared to the previous quarter, based on a measure used by other major economies.

The GDP figure was pulled down by a growing trade deficit, which hit a record high in March as import volumes and prices rose. The robust import demand and the change in the trade deficit reduced GDP because it is a measure of production. The report showed that net exports of goods and services fell by 3.2 per cent in the first quarter.

The headline figure contradicts the continued strength of U.S. household incomes. Private consumption grew by 2.7 per cent. in the first quarter against 2.5 per cent. at the end of last year. However, it was weaker than the forecast of 3.5 per cent.

“The headline figure looks a little worrying, and it came in weaker than expected. But digging beneath the surface, it pretty much painted a picture of robust domestic demand in the first quarter,” said Kathy Bostjancic, U.S. chief economist at Oxford Economics.

The data comes as fears rise that inflation and aggressive austerity measures from the Federal Reserve will trigger an economic recession. A widely used recession indicator – the inversion of the yield curve – flashed short red earlier this month.

Following the report, government interest rates rose across maturities, and an initial flattening of the yield curve was reversed. Trading in futures on the stock markets was volatile, with both S&P and Nasdaq contracts rising by more than 1%.

Growth in the US is threatened by the highest inflation in 40 years as the Russian invasion of Ukraine has driven up commodity prices and the current shutdowns in Beijing herald further supply chain problems. There was further evidence of price pressure in the report: the so-called core PCE, the Fed’s preferred target for inflation, which removes the volatile food and energy sectors, rose by 5.2 per cent compared to 5 per cent last quarter.

The Fed has indicated that it will react strongly to inflation, with markets pricing a half-percentage point rise in interest rates at its next meeting in May. Investors in the futures market now expect the central bank to raise its key interest rate to 2.7 per cent. at the end of the year, up from between 0.25 and 0.5 per cent. Today.

But the full effects of inflation and tighter monetary policy have not yet been translated into GDP.

A revision of how retail sales are calculated – announced by the Census Bureau on Monday – also limited growth in the first quarter and is expected to strengthen GDP in the second quarter.

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