Market Insider

The economic decline in the first quarter reveals even weaker consumers and more unknowns ahead

Key Points
  • Economists are reassessing their views of the second quarter's gross domestic product after first quarter GDP showed a bigger hit to consumer spending than expected.
  • The outlook for the second quarter, already grim, is murkier because the extent of the economy's reopening is still unclear.
  • The fact that an estimated 30 million workers have filed unemployment claims means job losses could take an even bigger toll on the economy.
A person walks by rows of stores closed during the outbreak of the coronavirus disease (COVID-19) in New York, March 28, 2020.
Andrew Kelly | Reuters

Consumers reined in spending faster than expected in the first quarter, probably even before states issued stay-at-home orders.

That raises questions about how consumers will behave as the economy begins to reopen and consumers are able to participate in a broader range of economic activities outside the home.

Economists are now assessing their forecasts for the second quarter's gross domestic product after Thursday's report that first-quarter GDP contracted by 4.8%. That was deeper than many thought it would be, and a surprise 7.6% plunge in consumer spending was partly to blame. Consumer expenditures make up 67% of GDP.

For the second quarter, economists had expected an unprecedented contraction in GDP of anywhere from 20% to 45%. The steepest drop in the Great Recession was 8.38% in the fourth quarter of 2008.

The decline in the first quarter was abrupt after states issued stay-at-home orders beginning in mid-March. But consumers may have reacted to worries about the spread of the coronavirus even sooner. Some states began to reopen activities in the last week.

"The big decline was the 10.2% in services consumption. That would suggest households were already engaged in social distancing, well ahead of the stay at home orders. If there's a potential piece of good news in this report, the savings rate did move sharply higher. It moved a little bit above 10%," said Michael Gapen, chief U.S. economist at Barclays. "That's normal when households move into cautionary mode. They spend less, they save more."

Gapen said the theory is that consumers will have some cushion to drive spending once the economy reopens, but with the unprecedented nature of the shutdowns and millions of job losses, it's difficult to foresee how much and how quickly a rebound can occur. He expects, after Thursday's latest jobless claims report, that an estimated 30 million workers will have filed for unemployment benefits, and April's unemployment rate would have climbed to 19%.

Barclays expects among the steepest contractions in the second quarter, at 45%, and Gapen said he will be reviewing his forecast to see if some of the negative activity occurred more in the first quarter than in the second.

After Wednesday's GDP report, ING economists said they now see a 40% decline in the second quarter. They noted that annualized, that would be minus 10% quarter on quarter. That means U.S. economic output would be down 13% peak to trough. "This is on a par with the downturn experienced as World War II concluded, but that occurred over three years, not two quarters as is happening today," the ING economists said.

Consumer spending will be hampered by travel restrictions as states begin to reopen, and there will be limited rebounds in the airline and hotel business in the quarter, the economists noted. Some restaurants and bars may also be forced to permanently close because social distancing may make them unprofitable.

"Even if we assume the bulk of the lockdowns start to ease from mid-May, ongoing social distancing, consumer caution and the legacy of 30 million unemployed Americans will ensure spending through June remains well down on the levels of January and February," they noted.

JPMorgan economists said consumer spending would have looked even worse if it were not for the 6.9% increase in spending on nondurables, or things consumers shopped for at grocery stores. There was a sharp decline in business spending on services. "Within services, double-digit annualized declines were recorded in health care, transportation services, recreation, and food services," they noted,

Diane Swonk, chief economist at Grant Thornton, said it was surprising how much health services declined for things like elective surgery and showed an impact on that industry even before hospitals filled up with patients infected with coronavirus.

 She said an 8.6% decline in business fixed-investment spending was also a surprise, and she will be reworking her GDP forecast for the second quarter over the next month.

"That's something I think people are forgetting about as well," she said of the business spending. The business investment has been undermining our potential for growth for awhile."

The actual 4.8% decline in the first quarter was more than many had forecast.  Economists had expected a 3.5% decline in GDP, according to Dow Jones consensus.

"The fact that we got that much of a loss reinforces our view that even as the economy opens up in the second quarter, it's still going to be horrific," Swonk said. "The spillover effects weren't only at the end of the quarter. It's pretty stunning how little time it took to derail a whole quarter."