GDP Pushes Dollar Down Further

The foreign currencies are mostly extending their gains against the greenback following the initial estimate of Q1 GDP.  The 2.2% pace was a bit disappointing to market expectations which had appeared to creep higher in recent days. 

The details are a bit better as household consumption was stronger at 2.9% after a 2.1% pace in Q4 11.   This accounted for about 2 percentage points of the 2.2% growth.  How is the consumption being financed?  Real disposable income rose 0.4% in Q1 after a 1.7% gain in Q4, which may help a bit, but it seems the key was the drop in savings from 4.5% to 3.9%. 

Final sales, which excludes inventory changes rose 1.6% up from the 1.1% gain in Q4. Inventories are difficult to forecast and are often a key favor behind the volatility of quarterly growth figures.  Inventories contributed 0.6% percentage points to the 2.2% GDP figure.  In Q4, inventory accumulation added 1.8 percentage points. 

Business investment slowed considerably and the 1.7% expansion in software and equipment spending is the slowest in nearly 3 years.   The curtailing of the tax incentive took its toll after a 7.5% rise in Q4. 

None of this is all that surprising, so where is the miss?  Contrary to what passes as conventional wisdom, the main drag is coming from the government itself.  State and local government spending fell 1.2% at an annual rate and spending by the Federal government fell 5.6%.  Of note, defense spending continues to plummet.  It fell at an 8.1% pace after dropping at a 19.1% pace in Q4.  

If there is a surprise in the other direction it is from residential construction which accelerated to a 19% pace from 11.6% in Q4.   

The key from a policy making point of view is how the actual data compares with the Fed's forecasts.  The FOMC indicated that it expects the economy to remain moderate over the coming quarters and improve gradually.  The data is very much consistent with that view.   

The contraction in manufacturing output in March, the mostly softer April Fed survey data, is likely to be followed by softening of the national ISM figures next week and a more moderate pace of job growth.   That said, expectations for the current quarter is for around 2% growth.  Recall too that the first estimate of quarterly GDP is often subject to statistically significant revisions. 

The strength of the foreign currencies remains somewhat counter-intuitive.  Spain's two-notch downgrade, pressure on the European bonds, the French and Greek elections a week away, an RBA rate cut and still they rally.  As we noted at the start of the week, technical indicators are more constructive than our assessment of the underlying fundamentals.