The American economy is expected to have recorded a significant slowdown in the first quarter. However, there is wide disagreement as to how much. Given the general pessimism in the market, that lack of consensus opens the possibility for significant market moves. How the US economy performs is likely to have global effects.
One of the theories held by some analysts is that if the US economy significantly underperforms in the first quarter, this could cause US President Donald Trump to back off on tariffs. Trump has already been giving constructive signs on the trade front this week, claiming to be near deals with India, South Korea and Japan. And even seeing progress in talks with China (though the latter disagrees). So, this could produce some counterintuitive moves in the market.
It’s All Going Down
While headlines have focused on the effects of tariffs, a decline in US economic activity in the first quarter isn’t a surprise. Q4 growth was unexpectedly strong, and economists last year were already predicting Q1 would be lower on a sequential basis. But not anywhere near negative.
Markets maintained the “American exceptionalism” optimism that US economic growth would outpace other major economies that were facing headwinds this year. That all came to a screeching halt when the Fed’s GDPNow tracker suddenly turned massively negative after a large US trade deficit driven by anticipation of tariffs. Since then, the debate among economists has been just how bad things will be in the first quarter.
Figuring Out the Projections
A closer look at the GDPNow figure, however, shows that there is considerable uncertainty around the economic forecasts. This is because the Fed’s nowcaster had to be adjusted for the first time ever to account for the large changes in trade. While the US recorded a significant increase in the trade deficit, this did not take into account large importation of gold. Gold is recorded as a monetary good, and therefore isn’t included in the trade balance.
Taking this into account, the GDPNow figure sees US Q1 GDP at -0.4%, a very different situation from the -2.5 of the unadjusted figure. And that doesn’t take into consideration other factors. For example, if businesses were “front-loading” imports ahead of tariffs, those goods will now appear as inventories. That would offset the negative impact of the trade balance, bringing the GDP figure higher.
What to Look Out For
As such, the consensus among economists is that the US Q1 GDP growth rate will fall to 0.5% on an annual basis. This is much slower than the 2.4% recorded in Q4. But, it’s still above what many traders might be worried about, which is a negative figure. And beating that really slow growth rate isn’t all that hard, meaning there is a substantial chance that the figure could outperform.
But that doesn’t mean the market will cheer. In fact, a faster growth rate might mean the Fed will keep rates unchanged, and the White House will stick to its guns on trade. So the market could lose some risk appetite. On the other hand, if GDP is negative, there could be fight between worries of an incipient recession, and hope that the Fed will now be forced to ease rates.
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