A down quarter for GDP could alter FOMC’s rate outlook

By Theresa Sheehan, Econoday Economist
April 28, 2022

The downside surprise of a 1.4 percent decline in first quarter 2022 GDP in the advance estimate may shake convictions that the FOMC will raise the fed funds rate by 50 basis points when they meet on May 2-3. It certainly makes an argument that caution should be exercised to keep the US out of recession by overdoing the removal of stimulus from monetary policy.

However, the composition of growth in the first quarter suggests that the fundamentals for the domestic economy are still pretty good and that the decline is due more to geopolitical events that weakness at home. The decrease would be more worrisome except that consumer spending and gross investment both rose solidly in the first quarter. Most of the blame for the decline is in net exports where things like the appreciation in the US dollar, China’s zero-Covid policy, and the war in Ukraine may be having an outside and short-term impact. Also worth noting is that it is not unusual for the first quarter to be a slow one. Although the BEA has worked hard to eliminate it, there still is a thing called “residual seasonality” that seems to affect the first quarter data.

In any case, the communications blackout period around the FOMC meeting is in effect (midnight Saturday, April 23 through midnight Thursday, May 4). Even if policymakers wanted to send a signal, Federal Reserve policy will stay mum during this time. The only exception might be if Chair Powell determined that it was necessary to say something to quiet markets.

One down quarter does not make a recession, and the NBER’s criteria for a recession include more than two consecutive negative quarters for GDP. In regard to the Fed’s dual mandate, the labor market remains strong with plentiful job openings and insufficient qualified workers to fill them. As for price stability, inflation is a major concern. Even if upward pressure is leveling off, it persists well above the 2 percent flexible average inflation target. If the dual mandate is consistent with full employment – and the data say it is – then the FOMC has room to act to address inflation. However, what FOMC voters may opt for is a smaller 25 basis point increase in short-term rates and a sooner and more aggressive reduction in its balance sheet as the safer alternative to lifting rates too quickly in uncertain times.