The economy shrank in the first quarter, but the core measures were strong

The US economy contracted in the first three months of the year, as supply constraints at home, a lack of demand abroad, and rapid inflation around the world weighed on the resilient recovery.

Gross Domestic ProductionThe Commerce Department said Thursday, after adjusting for inflation, it fell 0.4 percent in the first quarter. It was the first decline since the pandemic’s early days, and a sharp reversal from the rapid 1.7 percent growth in the last three months of 2021.

But the negative number obscures evidence of a recovery that economists said has remained mainly strong. The decline – 1.4 per cent year on year – was mostly caused by the inventories method and trade-in numbers, as well as lower government spending as Covid-19 relief efforts waned. Core demand metrics showed solid growth.

More importantly, consumer spending, the driver of the US economy, grew 0.7 percent in the first quarter despite rising gas prices and the Omicron wave of coronavirus, which limited spending on restaurants, travel and similar services in January.

“Consumer spending is the aircraft carrier in the middle of the ocean — it just keeps moving forward,” said Jay Bryson, chief economist at Wells Fargo.

However, this resilience could be tested in the coming months as the fastest inflation in four decades continues to take a heavy toll. Consumer prices rose at a 7 percent annual rate in the first quarter, and after-tax incomes of Americans, adjusted for inflation, fell for the fourth consecutive quarter.

The share of Americans who listed inflation as the most important household financial problem has reached a record high in the United States Gallup Survey Released Thursday. And 46 percent rated their personal financial situation positively, down from 57 percent a year ago, when the majority of families were newly benefiting from rounds of direct federal aid.

Despite this bleak outlook, higher prices have not discouraged consumers’ willingness to spend. That will change if inflation continues to outpace income gains, said Beth Ann Bovino, chief US economist at S&P Global. The savings rate in the first quarter fell below the pre-pandemic level for the first time, as consumers saved less in order to keep spending.

“There is a turning point,” she said. She added sometime this year, “I expect to see families start responding either by trading, looking for bargains, and being unwilling to pay higher prices.”

At Melting Pot, a national chain of nearly 100 fondue restaurants, revenue slumped in early January as rising coronavirus cases kept diners and staff at home. But reservations waned quickly, and Valentine’s Day — a “super bowl,” CEO Bob Johnston said — was the strongest of all. Sales are up 40 percent or more this spring from 2019, and growth will be stronger if franchisees can hire enough people.

“We are unable to meet the demand,” said Mr. Johnston. “We need more team members, and we’re struggling to keep the bench full.”

The Melting Pot raises wages to attract workers, and pays more for many ingredients. So far, it has been able to raise prices to offset the higher costs without losing business, but Mr. Johnston said he doesn’t know how long that will last.

“We try to be very careful with that, not to be overconfident in our ability to continue raising prices without any impact,” he said. “There could be a line we can’t see, and we don’t want to cross that line.”

Republicans took advantage of rising prices to blow up President Biden’s economic policies. Thursday’s report gave them room to escalate those criticisms.

“Accelerating inflation, a labor crisis, and the rising risks of a major recession are the Biden administration’s defining economic failures,” Representative Kevin Brady of Texas, the top Republican member of the House Ways and Means Committee, said in a news release.

The White House has sought to rule out the decline in GDP as a result of evasive data that does not reflect the overall strength of the economy.

“While last quarter’s growth estimates were affected by technical factors, the United States faces Covid-19 challenges around the world, Putin’s unprovoked invasion of Ukraine, and global inflation from a position of strength,” Biden said in a statement after Biden’s announcement. Their release, in reference to Russian President Vladimir Putin.

In fact, the weakness in the first quarter was partly related to the strength of the US recovery compared to the rest of the world. US retailers responded to consumer demand by importing more. At the same time, US exports have slowed due to weak economic growth abroad. As a result, the trade deficit ballooned, moving more than three percentage points away from the change in gross domestic product in the first quarter.

“The moral of the story is that the Omicron wave, the war in Ukraine, and the new lockdowns in China have been more costly to grow abroad than it was at home,” said Diane Sonk, chief economist at accounting firm Grant Thornton. Domestic spending has been remarkably flexible. It actually accelerated.”

The slower inventory expansion slashed roughly another percentage point from growth. Companies scrambled to ramp up stocks in late 2021 to make sure supply chain disruptions don’t leave them bare shelves during the holiday season. This means they don’t have to restock as usual in the new year.

A measure of core growth that removes the effects of inventories and trade rose 0.6 percent in the first quarter, after adjusting for inflation. That was a modest acceleration since the end of last year.

However, economists cautioned not to dismiss the effects of inventory and trade entirely. Both reflect the challenges local producers face in meeting extremely high consumer demand.

“If we are importing things rather than making them here, it reflects that we are asking for more than we can produce,” said Wendy Edelberg, director of the Hamilton Project, the economic policy arm of the Brookings Institution. “It indicates that our economy does not have the capacity to meet demand.”

The Fed is trying to curb demand by raising interest rates, which policymakers hope will curb inflation. But the Russian invasion of Ukraine and a new round of Covid lockdowns in China have complicated their job by prolonging supply outages, which the central bank can do little about.

Matt Younger, who owns a small construction company in Annapolis, Maryland, deals with long delays and higher prices for everything that goes into building a home: two by four, plywood, windows, garage doors.

“It’s like playing chess – I have to be a couple ahead of everything in case I can’t have something,” he said.

Now, rising interest rates threaten to cool a sweltering real estate market. Mortgage applications fell sharply, sales the new And existing homes It’s down, too, and anecdotal evidence from across the country suggests that the frenzy of bidding wars that has characterized the residential property market for most of the past two years has to start fading away.

But so far, none of that has slowed construction work. Residential construction grew 0.5 percent in the first quarter, only slightly slower than in the last quarter of 2021, and applications for building permits rose in March. Mr. Younger’s business is still thriving.

Mr Younger said he stopped offering fixed-rate contracts because he wasn’t sure in advance how much the materials he was using would cost. Eventually, he believes, some renovation clients will scale back projects to fit their budgets. But in terms of new homes, there is such a housing shortage in the Washington area that he suspects demand will dry up — and even if sales slow, he can always rent out the homes he’s building.

However, further in the supply chain, some companies are under pressure.

Marilyn Santiago operates Creative Architectural Resin Products, a Florida-based manufacturer of rafters, blinds, and other decorative features for homes. Ms. Santiago, like Mr. Young, has seen her material costs rise sharply in recent months. But it has struggled to pass these increases on to its customers of home builders as they look for ways to keep their costs down.

Construction delays also wreaked havoc on Ms. Santiago’s business. Its products generally can only be installed after the home’s windows, and with windows in back demand across the country, its warehouse is overflowing with off-the-shelf parts that were meant to be delivered months ago.

“If you come to my house you will see a bunch of bows, and my truck is a warehouse too,” she said.

Now Mrs. Santiago is considering acquiring a new warehouse – but storage prices have gone up, too.

“It’s as if everyone is taking advantage of the situation – and we, as small business owners, are basically a punching bag for the world of supply and demand,” she said.

Jenna SmyalekAnd Talmon Joseph Smith And Anna Swanson Contribute to the preparation of reports.