Winter wipeout: Economy shrank 2.9 percent in first quarter

All it took was an icy wind from the Arctic to topple the economy into its worst contraction since the depths of the Great Recession of 2007-2009.

That’s what the latest report from the Commerce Department showed Wednesday, revealing a shocking 2.9 percent drop in economic output during the winter quarter that amounted to the biggest loss of economic traction since the first quarter of 2009, when the economy and financial markets were in free fall.

The aftermath won’t be anywhere near as severe this time, however, according to the majority of economists who blame the rare one-quarter collapse of economic growth on the “Arctic vortex,” which brought a deep freeze and icy conditions to most of the country and prompted consumers and businesses — the main engines of economic growth — to go into hibernation for much of the quarter.

For one thing, rather than lose a breathtaking 2.3 million jobs during the quarter, as the economy did in early 2009, the economy actually generated nearly 600,000 jobs during the past winter quarter — showing that the one-time deep contraction did not reflect the economy’s underlying health and vitality, they say.

“This was as much a weather-induced bump in the road as it was the economy hitting the reset button following a second half of 2013 where growth clocked in at an unsustainable 3.3 percent average,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets.

Various handicaps created by the recession and financial crisis — ranging from a battered and still sickly housing market to overleveraged and underpaid consumers who have little access to credit or wherewithal to increase spending — have made it impossible for the economy to sustain growth much above its unofficial “speed limit” of 2 percent for long, Mr. Porcelli said.

Thus the economy was sure to fall back after setting a robust 4.1 percent growth pace in the summer quarter of last year and a solid 2.6 percent pace in the fall quarter, he said. And now it is widely expected to bounce back from the winter’s deep freeze with a surge of growth of between 4 percent and 5 percent in the spring quarter, from April to June.

“The first quarter is not reality any more than the expected second quarter bounce is reality,” said Mr. Porcelli. “And once the dust settles from this noisy first half, economic growth will sit pretty much where it has for the last few years — right around 2 percent.”

The stock market took the same sunny view of Wednesday’s unexpectedly dismal economic report as the majority of economists who dismissed it as a one-quarter fluke, with all major indexes posting solid gains for the day. But some analysts said the economy’s sudden shift into reverse gear brought a jolt of reality that underscored the fundamental weaknesses that will eventually bring the recovery to an end.

“The weather was a straw man,” said Peter Schiff, chief executive of Euro Pacific Capital. “When winter gets nasty, the economy does slow noticeably. But the drag is not nearly enough to explain away the current lethargy,” he said.

He estimated that previous harsh winters in the U.S. reduced growth on average to about 0.5 percent in the first quarter, rather than sending it into reverse.

“So, at best, the winter accounted for half the disappointment,” and the rest of the quarterly contraction reflected the economy’s underlying decay, he said. “The fundamentally weak and contracting economy is being artificially propped up by Federal Reserve stimulus, illusory accounting and massive federal deficit spending.”

Health care blamed

The official explanation for the economy’s big reversal of 2.9 percent was the failure of consumers to purchase health insurance, as required under the Affordable Care Act as of January 1.

In previous estimates of growth during the quarter, the Commerce Department had assumed spending on health insurance would surge by 9 percent, driving up consumer spending by 3.1 percent and propping up overall growth so that the weather-related decline in the economy was limited to 1 percent.

But the Obama administration effectively pushed back the deadline for individuals to purchase health insurance to March 31 from January 1, prompting the department on Wednesday to publish revised figures that showed consumer spending actually lost momentum during the winter and grew at only a 1 percent rate.

Many economists now expect the surge in health-related spending to show up in the spring and turbocharge growth in that quarter, which ends June 30.

The revision to consumer spending was responsible for 1.4 percentage points of the 1.9 percentage point downward revision in estimated growth, the department said. Also subtracting 1.7 percentage points from the growth rate was an overaccumulation of inventories by U.S. businesses, which had to be run off during the quarter, it said.

Economists were put off by the missed estimates on health care spending. Doug Handler, chief U.S. economist at IHS Global Insight, called it “a bit worrisome” and said further fluctuations related to Obamacare can be expected in the future.

But “since this volatility is not business cycle-related, its impact should be heavily discounted in assessing the general health of the economy,” he said.

In his view, “the recessionlike quarter was adversely affected by the weather and an unusually large drop in inventory growth, which is a correction from the last half of 2013,” he said. “Neither of these factors persisted in the second quarter, and we expect to see a rebound in growth to the 3.5-to-4.0-percent range.”

Export and investment dips

Exports and business investment also were strong negatives for the winter economy, falling by 8.9 percent and 1.2 percent, respectively, the department found. Net exports subtracted 1.5 percentage points from the growth rate, it said. And housing investment plummeted for the second straight quarter, this time by 4.2 percent.

Also weighing on the economy, state and local governments continued their retrenchment, cutting spending by 1.7 percent. Just about the only parts of the economy that were able to generate much growth were federal nondefense spending, which shot up by 5.9 percent, and business spending on software and other intellectual property, which jumped by 6.3 percent.

“The highest reasonable estimate for the weather impact in the first quarter wouldn’t be near as large as -2.9 percentage points, so there was clearly more going on,” said Ted Wieseman, economist at Morgan Stanley. “In particular, it looks in retrospect like the adds from inventories and trade in the second half of last year were substantially overstated, and that was corrected in a big way in the first quarter,” he said.

“Inventories are poised to swing to a positive contribution in the second quarter, and trade should be a significantly smaller drag, while underlying private domestic demand has accelerated significantly as weather drags have reversed,” he said, predicting a growth rebound of 4 percent this spring.