U.S. Q1 real GDP decline is a fraction of expected Q2 decline

*U.S. real GDP declined by 4.8% q/q annualized in Q1, the largest decline since Q4 2008, lowering its yr/yr change to 0.3% from 2.3% (Chart 1). Nominal GDP, the broadest measure of current dollar spending in the economy, fell by 3.5% q/q annualized, as the implicit price deflator increased by 1.3% (Chart 2).

*Real business fixed investment (-8.6% q/q annualized) and consumption (-7.6% q/q annualized) both declined sharply, while residential fixed investment surged by 21% q/q annualized due to robust performance in January and February and government purchases increased by 0.7% q/q annualized. The trade deficit narrowed and added 1.3pp to domestic production, reflecting a larger decline in imports relative to exports. Inventory investment subtracted 0.5pp from growth.

*The shutting down of activities in the second half of March was enough to lead to a sharp contraction in Q1 GDP, so the April shutdown and the expected gradual resumption of some activities in May and June point to a much larger decline in real GDP this quarter. We forecast a 35% q/q annualized decline in Q2 real GDP. The anticipated pace of rebound is very uncertain, as it hinges on developments in health care, in particular, various testing for COVID-19, the development of effective therapeutics and eventually, a vaccine.

The 3.5% q/q annualized decline in nominal GDP lowered its yr/yr change to 2.1% from 4.0%. The expected sharp decline in nominal GDP in H1 reflects a massive drop-off in aggregate demand for a broad array of goods and services. We expect this drop-off in demand to outweigh the productive capacity constraints resulting from the shutdowns and put downward pressure on prices (Temporary moderate deflation despite aggressive monetary expansion, April 28, 2020). The headline PCE price index increased by 1.3% q/q annualized in Q1, a deceleration from 1.4% in Q4, while the core PCE price index, which excludes food and energy, increased by 1.8% q/q annualized in Q1, compared to 1.3% in Q4.

Real consumption, which accounts for nearly 70% of U.S. GDP, tumbled by 7.6% q/q annualized, its largest decline since Q2 1980, reflecting a 10.2% decline in services consumption (the largest drop in quarterly data going back to 1947) and a 16.1% q/q annualized decline in durable goods consumption (Chart 3). Consumption of nondurable goods increased by 6.9% q/q annualized as food and beverages purchased for off-premises consumption surged by 25.1% q/q annualized (Chart 4). Consumption will be a positive contributor to the economic recovery as some activities are allowed to resume, but the pace of rebound will depend on household confidence, which hinges critically on advances in the medical space, particularly reliable and certifiable testing, and effective therapeutics.

Real residential fixed investment surged by 21% q/q annualized in Q1, the strongest gain since Q4 2012, reflecting the strong momentum from low mortgage rates, favorable demographics and shortage of reasonably-priced homes for sale (Chart 5). Clearly this momentum has halted and real residential fixed investment will decline sharply in Q2. However, we expect growth in housing activity to resume once the acute stage of this pandemic ends given that construction will be one of the first activities to resume across the states in which it was deemed “non-essential”, and as historically low mortgage rates and price declines in some regions pull potential buyers off the sidelines (US housing starts fall sharply in March, but April will be worse and Comments on US housing).

Real business fixed investment declined by 8.6% q/q annualized, reflecting a 15.3% drop in equipment investment (largest decline since Q1 2009) and a 9.7% q/q annualized decline in structures investment. Intellectual property investment eked out a 0.4% q/q annualized gain. We expect real business fixed investment to remain weak after the worst of this crisis ends, as businesses focus on their basic operations, rather than expansion projects that involve heavy capital spending. Moreover, declining energy prices will continue to drag down investment in oil/gas wells drilling and exploration and supporting sectors (Chart 6).

Government purchases increased by 0.7% q/q annualized in Q1, its smallest gain in five quarters, reflecting decelerations in national defense (Q1: 0.8% q/q annualized, Q4: 4.4%), and state and local government (Q1: 0.1% q/q annualized, Q4: 2.0%) categories. This decelerating trend will reverse in Q2, because of the government’s very large fiscal initiatives highlighted by the CARES Act and subsequent legislation. All of the increased provision of health care services financed by the government ‑- on the federal and state and local levels ‑- will add to government purchases.

Net trade contributed 1.3pp to Q1 real GDP growth, reflecting the massive 15.3% q/q annualized decline in real imports and 8.7% q/q annualized decrease in real exports (Chart 7). Imports will continue to decline sharply reflecting weak domestic demand. The declines in global economic activity and trade volumes, and stronger dollar will continue to weigh on exports.

Inventory investment subtracted 0.5pp from Q1 real GDP growth, but will add to Q2 real GDP growth as the sizable drop in demand leads to an undesired buildup of inventories. As the economy starts to recover in H2, we expect production to remain subdued as businesses drawdown inventory.

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Roiana Reid, roiana.reid@berenberg-us.com

Member FINRA & SIPC
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