FOCUS U.S. GDP growth masks weakness, Fed still to ease rates further

WASHINGTON (AFX) - Apparent resilience in the stronger-than-expected Q1 U.S. GDP expansion masks a number of underlying signs of weakness, analysts said, concluding that the Federal Reserve will still ease monetary policy further."The rise was better than expected, but I would still not call it a great report for the economy," said Mike Moran, chief economist at Daiwa Securities America in New York."It vastly overstates the health of the U.S. economy," said Mark Vitner, economist at First Union Corp.The Commerce Department earlier reported that U.S. GDP was up 2.0 pct in the first quarter, double the 1.0 pct rise in the fourth quarter last year.The rise "won't prevent modest further easing" by the Fed, however, said Ian Shepherdson, chief U.S. economist at High Frequency Economics, in a note to clients."The Fed is still scared about Q2 and Q3," he said.Moran noted that the trade deficit was a smaller drag on first quarter GDP, and thus contributed positively to the headline number. However, this came from fewer imports, which is simply a reflection of softer domestic demand, he said.The boost from trade added 1.4 pct to GDP growth in the quarter, Shepherdson said."Also, part of the improvement came from government spending (which) added 0.7 pct to GDP growth," but this was "probably just quarter-to-quarter volatility," and is unlikely to be sustained, Moran said.Analysts focused on the second quarterly decline in business investment in equipment and software, particularly as the Federal Open Market Committee introduced its concern with this area last week, after its surprise inter-meeting rate cut."This report confirms what the Fed said (last week) that the risks are now in eroding capital spending, and not the previous (concern) of an inventory" correction, Vitner said.Inventories were drawn down in the first quarter.Vitner also warned that the decline in equipment and software investment as reported in the GDP release is somewhat smaller than the drop actually being experienced by the economy.Because the government adjusts such business investment spending by accounting for quality and technological improvements, the relatively small decline in such spending masks a much larger decline in actual volumes, Vitner explained.Moran cautioned that consumer spending and residential investment, which contributed substantially to the overall first-quarter expansion, is unlikely to be sustained.Consumer spending is not going to have the same performance in the second quarter, as the decline in equity values in recent months, along with the large numbers of layoffs, take their toll, he said.Vitner noted a recent Labor Department report showing 545,000 job layoff announcements in the first quarter."Economic conditions are a whole lot worse than this report indicates," he concluded.Moran concluded the Fed "will not be satisfied. I think they will see risks on the downside," and predicted at least a 25 basis point cut in the Fed's key federal funds rate, which now stands at 4.5 pct, at the May 15 FOMC meeting.Vitner agreed that a 25 basis point rate cut is most likely, given that final sales growth in the first quarter may still restrain the Fed from a half percentage point reduction.Shepherdson agreed: the report is "clearly not good for those looking for sub-4.0 pct fed funds." 

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