Economy Shrinks in 1Q; Rising Dollar Hits Corporate Profits

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Economy GDP
Charlie Riedel/AP
By Lucia Mutikani

WASHINGTON -- 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 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.

%VIRTUAL-pullquote-We're going see enough growth to keep job creation in place and allow the Fed to maintain their lift-off schedule for September.%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 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 isn't 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 (SLM) and Halliburton (HAL) 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 1.9 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 such as Microsoft (MSFT), household products maker Procter & Gamble (PG) and health care conglomerate Johnson & Johnson (JNJ) 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 0.1 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.

9 Numbers That'll Tell You How the Economy's Really Doing
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Economy Shrinks in 1Q; Rising Dollar Hits Corporate Profits
The gross domestic product measures the level of economic activity within a country. To figure the number, the Bureau of Economic Analysis combines the total consumption of goods and services by private individuals and businesses; the total investment in capital for producing goods and services; the total amount spent and consumed by federal, state, and local government entities; and total net exports. It's important, because it serves as the primary gauge of whether the economy is growing or not. Most economists define a recession as two or more consecutive quarters of shrinking GDP.
The CPI measures current price levels for the goods and services that Americans buy. The Bureau of Labor Statistics collects price data on a basket of different items, ranging from necessities like food, clothing and housing to more discretionary expenses like eating out and entertainment. The resulting figure is then compared to those of previous months to determine the inflation rate, which is used in a variety of ways, including cost-of-living increases for Social Security and other government benefits.
The unemployment rate measures the percentage of workers within the total labor force who don't have a job, but who have looked for work in the past four weeks, and who are available to work. Those temporarily laid off from their jobs are also included as unemployed. Yet as critical as the figure is as a measure of how many people are out of work and therefore suffering financial hardship from a lack of a paycheck, one key item to note about the unemployment rate is that the number does not reflect workers who have stopped looking for work entirely. It's therefore important to look beyond the headline numbers to see whether the overall workforce is growing or shrinking.
The trade deficit measures the difference between the value of a nation's imported and exported goods. When exports exceed imports, a country runs a trade surplus. But in the U.S., imports have exceeded exports consistently for decades. The figure is important as a measure of U.S. competitiveness in the global market, as well as the nation's dependence on foreign countries.
Each month, the Bureau of Economic Analysis measures changes in the total amount of income that the U.S. population earns, as well as the total amount they spend on goods and services. But there's a reason we've combined them on one slide: In addition to being useful statistics separately for gauging Americans' earning power and spending activity, looking at those numbers in combination gives you a sense of how much people are saving for their future.
Consumers play a vital role in powering the overall economy, and so measures of how confident they are about the economy's prospects are important in predicting its future health. The Conference Board does a survey asking consumers to give their assessment of both current and future economic conditions, with questions about business and employment conditions as well as expected future family income.
The health of the housing market is closely tied to the overall direction of the broader economy. The S&P/Case-Shiller Home Price Index, named for economists Karl Case and Robert Shiller, provides a way to measure home prices, allowing comparisons not just across time but also among different markets in cities and regions of the nation. The number is important not just to home builders and home buyers, but to the millions of people with jobs related to housing and construction.
Most economic data provides a backward-looking view of what has already happened to the economy. But the Conference Board's Leading Economic Index attempts to gauge the future. To do so, the index looks at data on employment, manufacturing, home construction, consumer sentiment, and the stock and bond markets to put together a complete picture of expected economic conditions ahead.
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