The U.S. Commerce Department reported that the U.S. gross domestic product (GDP) contracted by 1.4% in Q1 which was a sharp turn from last quarter's blistering 6.9% gain. GDP is a measure of the total economy's output of goods and services. This was well below expectations of a 1% gain. It also increases concerns that the economy is slowing down just as the Federal Reserve is about to embark on a hiking cycle.
However, a deeper look at the report shows less cause for concern as some of the report was due to one-offs that aren't really indicative of anything meaningful. For example, there was a big increase in imports, while exports saw a big drop due to pandemic-related issues as the U.S. economy bounces back before other countries, especially in Asia. Another is the decline in defense spending and fixed investment which will be above-trend in future quarters.
The market reaction was interesting as stocks rallied more than 2% following the data likely on hopes that a slowing economy could alter the Fed's hiking timetable. And, the market found a bid at key technical support levels for the Russell 2000
However, these gains were quickly wiped out in the following session as the market faces the brutal reality of a tighter Fed and an economy that could be a negative shock away from a recession.
Some of the one-offs that impacted the report were Omicron and Russia's invasion of Ukraine. Additionally, inflation was felt sharply on a year-over-year basis. Other factors that were temporarily depressed in Q1 but should bounce back were inventories, government spending, imports, and defense spending. Inventories and defense spending accounted for a 0.9% drop in GDP. The trade deficit took 3.2% off GDP.
One bright spot was consumer spending which increased by 2.7%. However, there's likely some impact of rising prices, but consumer spending has not contracted which many expected due to inflation and higher comps. Currently, Wall Street banks are forecasting the odds of a recession at about 35% due to the Fed having to raise rates above neutral in order to bring down inflation.