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April 30, 1998
A GDP Paradox: Asia and El Nino Boost First Quarter Growth
CHARLOTTE, N.C. - Instead of hurting the U.S. economy, the first widespread impact of the Asia crisis was to lower mortgage rates and gasoline prices, both great news for U.S. consumers. Also, because the winter weather was much milder than normal (the El Nino effect), business that would normally have been postponed until spring was pulled forward, providing an additional boost. Quite a paradox. What were supposed to be problems have helped Gross Domestic Product (GDP) growth, so far at least.
First quarter real GDP rose at a 4.2% annual rate, even faster than the 3.7% rate of 1997. Residential construction soared at a 17.7% annual rate (compared with 5.1% in 1997), and real consumer spending surged at a 5.7% pace (compared with 3.5% in 1997).
"Because those first quarter gains were overstated due to the warm weather, we should expect second quarter real GDP to be understated, in the 2.0% range," said David Orr, Chief Capital Markets Economist at First Union Corp. "But rather than think of the economy as having surged, then slumped all within six months, it's more realistic to average the quarters and think of the underlying trend as about 3%."
Asia's negative impact did show up in the Trade Deficit (called Net Exports in the GDP), which worsened by $40 billion to a negative $199.7 billion, and cut 2.2 points off the total GDP. Businesses did not curb the expansion of inventory in the quarter. Inventories rose $77 billion vs $74 billion in the fourth quarter, which added 0.2 points to total GDP.
As has been the case throughout this decade, business investment continued to explode. It rose at a 17.5% annual rate. Spending on equipment surged 28.8% - Information technology equipment was the driver as usual, up at a 45.8% annual rate, led by computers at 99.2%. Almost 60% of that "real" gain in computers was due to declining prices since revenue growth rose by a lesser 40%.
As mentioned, we expect second quarter real GDP to slow to 2.0%, but then to rebound toward 3% later in 1998. If the Federal Reserve were thinking the same thing, they would likely be raising short term interest rates at their May 19 meeting. However, their forecast is for growth to slow to the 2.0%-2.25% range for the balance of 1998.
Therefore, they will have to wait until the third or fourth quarter figures are available before they decide whether to hold rates steady (because their forecast was correct) or to raise rates (because Asia did not slow the economy enough).
"Our bet is that they will eventually feel the need to tighten monetary policy, raising the fed funds rate from its current 5.50% to 6.0% during the first half of 1999," Orr said. "While that tightening would undoubtedly disturb the financial markets, at least temporarily, such a modest increase would not have any significant impact on most businesses. In our view, if it kept inflation below 2%, and curbed the reacceleration of speculative credit growth that began in late 1997, such a policy tightening would, paradoxically, provide more benefit than harm."
Orr is a senior vice president in economic research in First Union Capital Markets Corporation, a subsidiary of Charlotte-based First Union Corporation. First Union serves 12 million retail and commercial customers and operates full-service banking offices throughout the East Coast from Florida to Connecticut. First Union Corporation had assets of approximately $172 billion at March 31, 1998.
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