News that the U.S. economy contracted in Q4 for the first time since the recession ended is a shock. However, the 0.1% contraction (annualized) is an exaggeration of the economy's weakness.
A confluence of factors took a toll. The preliminary estimate is that inventories took 1.35% off GDP. Also with an incomplete information set, the next exports took another 0.25% off GDP. Government spending, which has generally been a drag on GDP (as cuts in state and local government spending more than offset the increased federal spending) took another 1.33% off GDP, with the defense spending accounting for the bulk of that.
Real final sales, which excludes trade and inventories, rose 1.3%, which is the weakest in a year. Personal consumption expenditures rose 1.5%, almost a third of which was vehicle sales. Software and equipment spending was also a net contributor to growth.
Consumption in Q1 will likely be hit by the end of the payroll tax holiday and higher gasoline prices. However, the drag from inventories is unlikely to be repeated. Washington's compromise on the fiscal cliff means that a Q1 hit on government spending has been deferred to Q2 and the sequestration.
The report, noisy as it is, may help ease ideas that had surfaced earlier this month that the Fed may look to soon pullback from its asset purchases. Inflation, as measured by the core PCE in the GDP report showed a 0.9% increase, down slightly from Q3's 1% increase. If anything the whiff of deflation is evident and this is keep the Fed on track, buying $85 bln a month in long-term securities. It also underscores the divergence between the passive tightening of conditions in the euro area and the full throttle easing in the U.S.