US Q1 GDP: Recovery Intact, Deflation Risk Remains

The first look at Q1 US GDP was largely in line with expectations. The 3.2% annualized pace was slower than the 5.6% of Q4 09, but every one recognized that that pace was not sustainable. Although growth seemed more solid, price pressures eased, further underscoring the lack of price pressures. Despite then the slightly above trend growth for the second consecutive quarter, the Fed remains securely on the sidelines.

Consumption rose 3.6% after a 1.6% advance in Q4. It contributed about 2.5 percentage points to the GDP figure. Inventories added about 1.6%. Business spending on equipment increased 13%, but its spending on structures fell 14%. And for first time in three quarters, house construction fell.

The core PCE deflator, among the Fed's most cited indicators of inflation, fell moderated to 0.6% from 1.8% in Q4. This is smallest increase in the core PCE deflator since the time series began in the late 1950s.

There does not appear to be any noteable economist who is forecasting a double dip recession. Some may talk about it, but it appears to be a tail risk and not the base line forecasts. The difference between the economic optimists and the pessimists seems to be the difference between 1.5-2.0% growth this year and 3.0-3.5. Both recognize that the fiscal policy will less supportive for the economy as the stimulus spending runs its course.

Government spending in Q1, in the preliminary estimate, shaved 0.4% off of GDP. That is to say it has already turned from a tailwind to a headwind. That headwind is likely to grow in the coming quarters.

However, that drag may be offset by improvement elsewhere. Job creation is key and so is the work week to boost incomes, consumption and output. But the drag from non-residential structures is lessening. Even though it was off 14% in Q1, that represents the smallest decline since Q4 08. A turning in the second derivative should continue.

The government does not have the full set of trade and inventory figures for the quarter and this is where economists will focus on for potential revisions, that historically are frequently statistically substantive.

The US consumer and business investment may be the key to growth going forward. The inventory cycle still appears incomplete and could still contribute to GDP over the next couple of quarters. Net exports are not so much a function of US growth as rest of the world's growth. However, on various models of valuation (e.g. PPP, FEER, REER), the dollar remains under-valued against the other major currencies and therefore its appreciation may not be an obstacle to increase exports.

Month-end considerations and the unwinding of some of the anxiety related to Greece appears to be overwhelming the GDP data in terms of market impact.