Ignore the Headline: Focus on Business Investment

Ignore the Headline: Focus on Business Investment

June 01, 2022

The U.S. economy shrank at an annualized rate of -1.4% in Q1, partially hindered by the COVID-19 Omicron variant during the first month of the year, but mainly due to a huge trade deficit.

Underlying demand from both consumers and businesses was quite resilient, given the headwinds of persistently high prices and Russia’s unjust invasion of Ukraine. Real final sales, which exclude trade and inventories, rose an annualized 2.6%, up from 1.7% in Q4. This is quite bullish for the fundamentals of the economy and will likely provide decent momentum heading into the rest of 2022. “Ignore the headlines for this specific report” explained LPL Financial Chief Economist Jeffrey Roach, “since the underlying details paint a very different picture.”

The largest drag on the economy in Q1 was the hefty trade deficit, dragging down headline growth by over 3 percentage points. Trade’s cut to headline growth was roughly as deep as the cut during the onset of the global pandemic. This negative impact will not likely repeat in the upcoming quarters as global sanctions stabilize. As we illustrate in the LPL Chart of the Day, real consumer spending and business capital spending contributed to growth in Q1 and we expect this to continue.

Momentum in high frequency data in April suggests that the current and upcoming quarters of growth are consistent with our forecast of roughly 3% GDP growth for the year. Low weekly unemployment claims so far this month and early readings on April sentiment indicators all suggest budding momentum for the economy despite rising borrowing costs and quantitative tightening. April housing indicators from the National Association of Home Builders could foreshadow a slowing in residential investment, but the drag will not be meaningful for upcoming headline growth figures.

This report does not change our expectations that the Federal Reserve will likely hike 50 basis points in May and possibly in June and then begin a 25 basis point cadence.

In summary, stripping out the highly volatile exports and inventories, real final sales rose an annualized 2.6%, up from 1.7% in Q4. Even more bullish is the strength in nonresidential investment. Firms increased spending on items such as computers and machinery, and this will likely provide momentum for the rest of the year. Overall, nonresidential investment grew an annualized 9.2%.