U.S. GDP Growth Revised Down to 1.6% in Q1 Amidst Shifting Contributions

U.S. economic growth in the first quarter of the year was revised downward to an annualized rate of 1.6%, falling short of both earlier estimates and market expectations of 2.0%. This adjustment largely stemmed from reductions in inventory accumulation and personal consumption expenditures, which more than offset stronger contributions from residential construction and net exports. Despite the headline slowdown, a closer look at corporate profitability reveals a robust performance.

The most significant takeaway from the latest data release was the substantial growth in economy-wide corporate profits. These profits increased by 0.9% in the first quarter and have surged 12.0% over the past year. Excluding the contributions of the Federal Reserve, corporate profits saw a 0.9% rise in Q1 and an impressive 11.0% increase annually, marking the fastest four-quarter growth since 2023. This Q1 growth was primarily driven by a 3.7% expansion in profits from domestic non-financial industries, even as profits from domestic financial companies decreased by 0.3% and those from the rest of the world fell by 9.8%. This robust corporate earnings picture, when fed into capitalized profits models, suggests that equity markets remain overvalued.

Delving further into the GDP components, "core" GDP, which comprises personal consumption, business investment, and residential construction—and excludes more volatile elements like inventories, government spending, and trade—posted a 2.4% annualized growth rate in Q1. This metric, which offers a clearer view of underlying economic momentum, was slightly lower than the initial 2.5% estimate. The revision downward mainly reflected softer consumer spending on services and a slight reduction in business investment in intellectual property. The discrepancy between headline GDP and core GDP growth can largely be attributed to trade, which subtracted 1.3 percentage points from the headline figure in the first quarter. This volatility in trade is anticipated to continue, influenced by recent policy changes and ongoing geopolitical tensions.

A key concern highlighted in the report is the persistent inflation. The GDP price index rose at a 3.5% rate in the first quarter and is up 3.3% year-over-year, remaining considerably above the Federal Reserve's 2.0% target. Nominal GDP, which combines real growth and inflation, increased at a 5.2% annualized rate in Q1 and 5.9% over the past year. Both figures are notably higher than current short-term interest rates. With the full impact of elevated energy prices still filtering through the economy, immediate interest rate cuts are unlikely. However, recent trends in broader money supply (M2) growth hint at potential disinflationary pressures emerging beyond the current geopolitical environment.

Key terms:

1. **Real GDP**: Gross Domestic Product adjusted for inflation, providing a measure of the actual volume of goods and services produced.

2. **Nominal GDP**: Gross Domestic Product measured at current market prices, without adjusting for inflation.

3. **Core GDP**: A measure of economic growth that excludes volatile components such as inventory changes, government spending, and net exports, focusing on consumer spending, business investment, and residential construction to indicate underlying demand.