Forex Investment and Currency Trading

The advance GDP report showed a steep 6.1% q/q saar contraction in activity in Q1, weaker than expected.  As expected, there was a massive $104 bn liquidation in inventories. This sliced 2.8pp from GDP growth. More than half of the decline in inventories was in the motor vehicle sector as automakers have slashed production in response to the severe drop in demand. The biggest surprise in the report was a 44% q/q saar plunge in nonresidential structures investment. This was twice as bad as expected and marked the biggest quarterly drop in post-war history. This rapid decline reflected a sharp downturn in construction of oil and natural gas drilling structures in addition to commercial real estate. Businesses also cut back sharply in investment in equipment and software. Also as expected, residential investment plunged 38% q/q saar, reflecting the notable decline in housing starts at the end of last year and early this year.

The weakness on the business side was partly offset by a gain in consumption and a narrowing in the trade deficit. Real consumer spending rose 2.2% q/q saar, above consensus expectations for a 0.9% increase. The gain was widespread with durable consumption up 9.4%, nondurables up 1.3% and services up 1.5%. The increase in durables consumption is consistent with the improvement witnessed in unit auto sales. The increase in consumption may partly reflect pent-up demand from a dismal holiday shopping season. Looking ahead, analysts expect a weak trajectory of consumer spending given the headwinds from rising unemployment and diminished household wealth. In addition to the 1.5pp contribution to consumption, trade added another 2.0pp to growth. The trade deficit shrunk to $308bn from $365 bn in Q4 as the 34% drop in imports offset the 30% decline in exports.

While GDP surprised on the downside, prices surprised on the upside. The GDP price index rose 2.9% q/q saar, above consensus expectations for a 1.8% increase. Similarly, the core PCE index rose 1.5% q/ q saar, translating to a 1.8% y/y increase. This leaves core PCE trending at a slightly higher pace than previously expected, reducing concerns about deflationary risks.

While the decline in GDP was bigger than expected, the silver lining is that the collapse in inventories is unlikely to be repeated in the coming quarters. Inventories are now falling as a share of GDP at a rate about as fast as we have seen in modern history. Thus if inventories fall by $104 bn again in Q2 the inventory contribution to growth will improve to zero from -2.8. This inventory “accelerator effect” is a key reason that some expect only a 2% drop in GDP in Q2. Moreover, by the second half of the year, some believe that the economy can crawl out of this recession provided the recovery in consumption persists.