U.S. Economy Shrinks In The First Quarter – Economic Highlights

Other key components of the release related to consumer, business and government spending effectively remained unchanged. All in all, the report doesn’t add anything new to our understanding of the U.S. economy’s Q1 performance and what it means from the Fed’s perspective.

We will get more incremental clarity about Fed policy from next week’s factory sector ISM survey and government jobs report. Second quarter data thus far shows some improvement in the economy’s growth momentum, but the rebound has been less than satisfactory. The April data showed that housing has bounced back and the labor market has come back from the first quarter’s pace. But the factory sector didn’t’ show any improvement and measures of consumer spending remained under pressure.

It is this mixed data that has pushed the start of the Fed tightening cycle to the September FOMC meeting at the earliest. The September is timeline is essentially a toss-up at this stage as well, with incoming data yet to determine the new frame of the market’s Fed outlook.

I don’t think the Fed ‘needs’ GDP growth to be in the +3% neighborhood to get comfortable in starting the tightening cycle. My sense is that they will be fine with starting the process as long as they are comfortable that the economy can sustain a moderate growth pace of around +2%.

That isn't a good scenario for stocks — we get the monetary tightening, but don’t get any of the good stuff that typically accompanies such cycles like faster economic growth and better corporate earnings.