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 (NYSE: IWM) and Nasdaq Composite (NASDAQ: QQQ). These factors can spark big gains in hours because the market is very oversold with high levels of bearish sentiment.
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.