America's GDP growth disappoints, economy already slowing

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1Q U.S. GDP Rises 2.5%

FBN’s Diane Macedo breaks down the latest report on economic growth.

The Commerce Department reported Friday that America's GDP (Gross Domestic Product) grew at a 2.5 percent pace in the first quarter but don’t break out the champagne. Several one-time factors contributed to this seemingly robust performance.

The economy is already slowing and new crises threaten. Most of first quarter growth likely was concentrated in January and February and the economy slowed, and it may have actually  contracted, in March.

In the fourth quarter, inventory investments and defense purchases were uncharacteristically weak—the former rebounded and the latter declined much less in the New Year. Also, extraordinary year-end corporate bonuses and dividend payments, intended to soften the blow of higher 2013 taxes, pushed up consumer spending early in the first quarter.

Those factors will not repeat in the second quarter, and January tax increases are finally starting to bite—consumers appear are hunkering down, and their confidence about the future is waning.

Higher payroll taxes and income taxes paid by the wealthy took away $165 billion in purchasing power. Working- and middle-class families adjusted spending to accommodate higher taxes, but with a lag, because they must keep driving to work and feeding their children—now car dealers and shopping malls report slowing sales.

For upper income families, changes in the tax code were extraordinarily complex, and many pay taxes on a quarterly basis on self employment and investment income. The full impact of higher taxes on their after-tax income was not reckoned until their accountants computed their first quarter payments due April 15—now they will be trimming purchases.

Along with sequestration, higher taxes are subtracting more than $200 billion from household purchasing power and government spending—that is slowing demand for what Americans make and makes jobs tougher to find.

A key element of the tax changes—reduced mortgage interest deduction—is dampening existing home sales. Holding up purchases are speculators, aided by the Federal Reserve’s easy money policies, and wealthy investors from continental Europe’s troubled economies who are parking capital in U.S. real estate.

They are scarfing up properties in choice markets in Florida, New York City and elsewhere with cash offers that frequently squeeze out ordinary homebuyers seeking a primary residence.

In several markets, prices have zoomed past what these ordinary buyer’s incomes will support; hence, speculators bets require that somehow after-tax household incomes will somehow surge permitting them to unload at a profit.

Slow growth and higher taxes on upper middle income and wealthy households makes that a dubious strategy, and the speculative surge cannot end well—housing price increases will slow, plateau or could crash all together.

The housing market bump to household wealth that has supported consumer spending growth in recent months will relent.

Similarly, the Fed’s low-interest policies are boosting stock and agricultural land values—at a pace beyond what future profitability of either asset class can sustain. Either slower growing values or outright adjustments appear inevitable, and the resulting drag on consumer spending will slow the recovery.

The continuing surge of Chinese exports onto American store shelves, and weakening demand for U.S. products in recession torn Europe are dampening demand for U.S. manufactures.

Japan’s weak yen policy is imposing tougher competition on U.S. automakers and other manufacturers of technology-intensive products. Already, the Commerce Department reported durable goods orders fell 5.7 percent in March, indicating much slower sales going forward.

The bottom line: most forecasters expect growth to slow to less than 2 percent in the second quarter and to remain below 3 percent through the end of 2014.