U.S. Q1 GDP contracts 1.4%: Is the economy heading towards recession?

The real gross domestic product (GDP) of the U.S., the world’s largest economy, fell unexpectedly in the first quarter (Q1) of the current financial year 2022, as the resurgence of the Omicron variant of Covid-19 and tapering of economic stimulus hit private investments, as per the government data published on Thursday. The U.S. real GDP dropped at an annual rate of 1.4% in Q1 FY22, as compared to 6.9% growth in the final quarter of 2021, according to the advance estimate released by the Bureau of Economic Analysis (BEA). The real GDP grew 5.7% in FY21, in contrast to a decline of 3.4% in FY20.

The Q1 GDP numbers were worse-than-expected as market analysts had projected a marginal growth of 1% in the March quarter of 2022.

“The decrease in real GDP reflected decreases in private inventory investment, exports, federal government spending, and state and local government spending, while imports, which are a subtraction in the calculation of GDP, increased. Personal consumption expenditures (PCE), nonresidential fixed investment, and residential fixed investment increased,” says BEA.

The fall in private inventory investment, a measure of the value of the change in the physical volume of the inventories, was due to a decline in wholesale trade (mainly motor vehicles) and retail trade, leading to a drop in net exports and inventories. Within exports, a fall in nondurable goods was partly offset by an increase in "other" business services (mainly financial services).

The other reason for the drop in Q1 GDP was a decrease in the federal government spending, which was dented by a fall in defense spending on intermediate goods and services.

However, the rise in imports and increase in personal income indicated that the U.S. economy is on a recovery path. While the rise in imports was led by increases in durable goods (notably, nonfood and nonautomotive consumer goods), the increase in personal consumption expenditures (PCE) was led by growing demand for health care services in wake of the Covid-19 pandemic.

“The increase in PCE reflected an increase in services (led by health care) that was partly offset by a decrease in goods. Within goods, a decrease in nondurable goods (led by gasoline and other energy goods) was partly offset by an increase in durable goods (led by motor vehicles and parts). The increase in nonresidential fixed investment reflected increases in equipment and intellectual property products,” the BEA report adds.

On impact of Covid-19 pandemic, the Commerce Department’s report says that an increase in infections related to the Omicron variant resulted in continued restrictions and disruptions in the operations of establishments in some parts of the country. “Government assistance payments in the form of forgivable loans to businesses, grants to state and local governments, and social benefits to households all decreased as provisions of several federal programs expired or tapered off.”

“The full economic effects of the COVID-19 pandemic cannot be quantified in the GDP estimate for the first quarter because the impacts are generally embedded in source data and cannot be separately identified,” it says.

Is the U.S. economy heading towards recession?

The first-quarter U.S. GDP estimates show a sharp decline in growth from the previous quarter, but this does not mean that the economy is heading towards a recession. According to Moody’s Analytics report, recessions require a significant decline in economic activity and the reductions must be broad-based over a period of several months. The agency expects GDP to expand 3% in FY22, a deceleration from 5.7% growth in FY21.

“From the period of 1960 through the global financial crisis and ensuing recession, a quarterly contraction in GDP in the U.S. was always associated with a recession—either immediately preceding it or, of course, occurring in the midst of one. However, after the Great Recession, during the decades-long expansion from 2010 to 2020, there were three instances of quarterly contractions in real GDP: twice in 2011 and again in early 2014, that did not portend or represent an economic recession,” the report says.

As per the report, the three quarterly contractions in GDP occurring between the global financial crisis and the Covid-19 pandemic occurred because of some combination of a widened trade deficit and the quarterly oscillations of the inventory build. However, consumption, the largest component of GDP, did not contract in those instances or in the first quarter of 2022.

The data showed that current-dollar personal income increased $268 billion in the first quarter, compared with an increase of $123.9 billion in the fourth quarter of FY21. Besides, disposable personal income increased $216.6 billion, or 4.8%, in the first quarter, compared with an increase of $20.1 billion, or 0.4%, in the fourth quarter.

Meanwhile, personal savings was $1.21 trillion in the first quarter, compared with $1.39 trillion in the fourth quarter. The personal saving rate—personal saving as a percentage of disposable personal income—was 6.6% in the first quarter, compared with 7.7% in the fourth quarter.