Negative 1Q GDP Growth: What This Means for Recession Risk

In this article we review:

• 1Q 2022 gross domestic product (GDP) growth, the first quarter of net economic contraction since the spring of 2020
• How this could impact the risk of recession during the year ahead
• The impact of inventory drawdown and trade imbalance on 1Q economic growth
• Why, despite the negative report, underlying demand may infer a strong recovery back to positive economic growth in 2Q 2022

The U.S. economy experienced negative growth in 1Q 2022 as GDP declined at an annualized rate of -1.4%, representing the first quarter of economic contraction since the COVID-19-induced collapse of 2Q 2020. According to the advanced estimate from the U.S. Bureau of Economic Analysis, GDP growth contracted despite strong demand within both the consumer and business sectors of the economy. Amid this unexpected report, we believe investors should consider the following:

While odds of a recession this year have now increased, we believe such an outcome is still likely to be avoided. Being that the official definition of recession is two consecutive quarters of negative economic growth, investors must come to terms with the fact of this criterion having now been halfway met. That said, the internal components of this 1Q GDP report also in our judgment infer a lower probability of negative growth in 2Q 2022. 

Two supply-oriented components — inventories and the trade deficit — accounted for more than the entire quarter’s GDP contraction. Following a strong build in 2H2021, inventories were worked down considerably in 1Q accounting, creating a negative annualized contribution of -0.84%. In addition, a $192 billion increase in the gap between imports purchased and exports sold negatively affected annualized growth by -3.2%. Together, these two supply-oriented factors amounted for more than the overall net GDP decline.

Consumer and business demand were strong for the quarter. Consumer spending actually exceeded most expectations at an inflation-adjusted annualized rate of 2.7%, as did business spending reflected by gross domestic private investment growth of 2.3%. When taking out the inventory work down, these two demand-oriented components grew by an annualized rate of 3.7%, which was above their 4Q 2021 combined pace of 2.6%. 

In our opinion, there is a strong probability inventories and the trade imbalance could reverse direction in the quarter ahead. Given the momentum in consumer and business demand, it is quite likely inventory purchases will rise in the months ahead. Furthermore, the wide disparity in the import-export gap could also decline meaningfully, as much of this past quarter’s variance was due to delayed overseas shipments finally coming to U.S. ports as global supply chains eased, potentially creating a short-term distortion in the amount of imported goods coming to shore. 

Wild cards for 2Q GDP growth include inflation, interest rates, and the war in Ukraine. Admittedly, these variables could play a major role in impacting the continuation of 1Q demand momentum now necessary to avoid the recession status of another negative growth quarter.  

In summary, while recession risk has increased, a strong probability remains for increasing consumer and business demand in the months ahead as COVID-19 transitions from pandemic to endemic status. Under such a scenario, the odds would likely favor positive economic growth in 2Q, perhaps in the 3% range or even higher, thus helping the economy to avert recession in the year ahead.

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