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First quarter GDP revised up as corporate profits give way

The Hill 4 days ago Tobias Burns
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First-quarter gross domestic product (GDP) was revised up on Thursday as the long-predicted recession following the blistering economic recovery from the pandemic once again failed to hit the U.S. economy.

GDP was corrected up 0.2 percentage points to a gain of 1.3 percent in the first quarter, according to the Commerce Department.

Analysts are again ambivalent about what this means for the broader economy and the contours of the current business cycle.

“The first quarter real GDP picture exemplifies [a] duality. Those seeing resilience in the economy will stress that while real GDP growth was soft at 1.3 percent in [the first quarter], final sales rose a robust 3.4 percent and final sales to private domestic purchasers … advanced an impressive 2.9 percent,” EY-Parthenon economist Gregory Daco wrote in a Thursday analysis.

“Conversely, those seeing fragilities will emphasize that the economy started the year on a soft note,” he added. “They’ll highlight similar weakness in sequential business investment momentum.”

Overall production levels are just one component of what the National Bureau of Economic Research (NBER) looks at when designating a recession. But other factors, like employment and spending, are still robust enough to indicate a serious contraction in the economy is not imminent and may not materialize at all.

Thursday’s numbers from the Commerce Department also showed corporate profits, which have gone through the roof during the recovery period and kept inflation higher than it otherwise would have been, are coming back down and giving way to labor as a share of overall value in the economy.

Profits as a share of real unit price fell from 15 percent of prices to 14 percent in seasonally adjusted terms, while labor costs moved up from 58 percent to 59 percent, according to a calculation made by The Hill using Commerce Department data.

“We’re starting to see a normalization here that we did not see certainly in the first half of 2022 and arguably throughout much of that year. This really started to happen over the last six months. Notably, corporate profits as a share of incomes in the economy declined for non-financial companies,” Mike Konczal, an economist and director with the Roosevelt Institute, a Washington think tank, told The Hill.

“That margin is starting to compress, and that’s useful,” he added.

However, over a larger time scale, profits are still significantly elevated above their pre-pandemic levels, which hovered around 15 percent for nearly a decade before the pandemic. 

They’re now still closer to 20 percent using a different adjustment, which adds weight to the argument that higher profits, enabled by an initial supply shock, are a significant driver of inflation post-pandemic.

Research by Konczal published in 2022 found that higher markups during the current inflation were carried out by companies with higher market power, suggesting firms were raising prices simply because they could — a power that is still frequently on display in earnings calls held by corporate managers.

“Pre-pandemic markups are a strong predictor of the increase in markups during 2021, suggesting a role for market power as an explanatory driver of inflation,” Konczal wrote.

“That didn’t explain all of inflation. There were still very obvious demand and supply-side stories in the data as well, but it did make me more confident that there’s a story here,” he said.

Decreasing margins along with decreasing inflation, which has fallen from a 9.1 percent annual increase last June to a 4.9 percent increase this April, is resulting in ambivalence on the part of Federal Reserve bankers, as well.

The minutes of the Fed’s most recent rate-setting committee meeting show that bankers are split about whether to keep raising interest rates in response to elevated inflation or take a break in light of cooling prices.

“Many participants focused on the need to retain optionality after this meeting,” the minutes say.

The sentiment was repeated by Fed Governor Christopher Waller, who introduced the possibility of “skipping” a rate hike at the committee’s next meeting, as distinct from pausing.

“There is a lot of discussion about the next step for policy. There are three options: hike, skip, or pause,” he said in a speech on Wednesday in Santa Barbara, Calif.

“Another hike combined with an abrupt and unexpected tightening of credit conditions may push the economy down in a rapid and undesirable manner,” he said. “If one is sufficiently worried about this downside risk, then prudent risk management would suggest skipping a hike at the June meeting but leaning toward hiking in July based on the incoming inflation data.”

Many economists think the Fed’s May rate hike was its last for the time being.

“Considering the FOMC minutes and recent Fed speeches, our view remains that the Fed’s early-May rate hike was likely the last of this tightening cycle, and we expect the Fed will hold rates steady in June and through the rest of the year as it assesses the impact of tightening to date on the economy and inflation,” EY’s Daco wrote.

Prediction algorithm FedWatch by financial company CME put the chances of a rate hike in June versus a pause at 50-50.

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