* U.S. GDP grew just below 1% (annualized) in 1Q 2008, with final sales to domestic purchasers falling (slightly) for the first time since 1991. Weak consumer spending, a pronounced shift to decline in business investment, continued rapid declines in residential investment and even a slowing in state and local government purchases were notable contributors. Businesses continued to liquidate inventories. Still soft (less than 1%) domestic final sales growth should continue this quarter, while market looks for continued improvement in net exports to push GDP growth to near 1% once again.

* Although home prices have declined rapidly in recent months, many indications of financial turmoil have receded, partly in response to the Fed’s creative mechanisms for enhancing financial market liquidity, including a facility for lending directly to primary dealers. Consistent with credit market improvement, major equity indexes have retraced part of their early-year declines. However, weakening labor markets continue to weigh on consumer credit quality, and there is survey evidence that financial institutions are still tightening lending standards. How these disparate trends combine to influence the degree of business caution on capital spending and hiring remains a key to the depth and persistence of the economic slowdown.

* Market expects below-trend 1.5% to 1.75% annualized consumption growth this year, as households face slowing payrolls, falling home prices, tight credit conditions and record energy costs. The Fed’s aggressive monetary easing and the temporary tax rebates should still have a stimulative impact in the middle quarters of the year. Improving ex-auto retail sales in March-April likely reflects these trends, but the seemingly inexorable rise in energy prices promises to limit the net positive impact on real spending.

* Amid slowing final demand, weakening profits and rising costs of capital, firms have reduced their capital spending plans. Provision in the stimulus legislation for the expensing of equipment purchases this year is providing some offsetting support to capital spending. Business investment in nonresidential structures slowed to near flat last quarter, following robust growth in 2007. State and local government purchases also are likely to be increasingly constrained by weakening tax revenues.

* Home sales are likely to level off later this year, as affordability continues to improve and credit conditions ease somewhat; however, declining home prices are also a key deterrent to housing recovery, leading potential homeowners to postpone purchases. Even after home sales level off, near-record inventories of homes for sale will delay a pickup in construction. Rising net exports, the result of stronger economic growth abroad and the significant declines in the U.S. dollar, will continue to add to GDP growth. However, with foreign economies not fully decoupled from the U.S. and showing their own signs of slowdown, net exports are also vulnerable.

* The Fed’s aggressive easing has lowered the funds rate by 325 basis points to 2% since last September. Amid considerable Fed anxiety over its inflation-fighting credibility and continued energy price increases, reflected in multiple dissents at recent meetings, the Fed is on hold for now. Market expects that continued below-trend GDP growth and a rising unemployment rate will eventually lead to modest additional easing, and project a 25-basis point ease to 1.75% at the September 16th FOMC meeting. Market expects Fed tightening to begin in mid-2009, once the unemployment rate has peaked and credit conditions substantially improved.

* U.S. GDP grew just below 1% (annualized) in 1Q 2008, with final sales to domestic purchasers falling (slightly) for the first time since 1991. Weak consumer spending, a pronounced shift to decline in business investment, continued rapid declines in residential investment and even a slowing in state and local government purchases were notable contributors. Businesses continued to liquidate inventories. Still soft (less than 1%) domestic final sales growth should continue this quarter, while market looks for continued improvement in net exports to push GDP growth to near 1% once again.

* Although home prices have declined rapidly in recent months, many indications of financial turmoil have receded, partly in response to the Fed’s creative mechanisms for enhancing financial market liquidity, including a facility for lending directly to primary dealers. Consistent with credit market improvement, major equity indexes have retraced part of their early-year declines. However, weakening labor markets continue to weigh on consumer credit quality, and there is survey evidence that financial institutions are still tightening lending standards. How these disparate trends combine to influence the degree of business caution on capital spending and hiring remains a key to the depth and persistence of the economic slowdown.

* Market expects below-trend 1.5% to 1.75% annualized consumption growth this year, as households face slowing payrolls, falling home prices, tight credit conditions and record energy costs. The Fed’s aggressive monetary easing and the temporary tax rebates should still have a stimulative impact in the middle quarters of the year. Improving ex-auto retail sales in March-April likely reflects these trends, but the seemingly inexorable rise in energy prices promises to limit the net positive impact on real spending.

* Amid slowing final demand, weakening profits and rising costs of capital, firms have reduced their capital spending plans. Provision in the stimulus legislation for the expensing of equipment purchases this year is providing some offsetting support to capital spending. Business investment in nonresidential structures slowed to near flat last quarter, following robust growth in 2007. State and local government purchases also are likely to be increasingly constrained by weakening tax revenues.

* Home sales are likely to level off later this year, as affordability continues to improve and credit conditions ease somewhat; however, declining home prices are also a key deterrent to housing recovery, leading potential homeowners to postpone purchases. Even after home sales level off, near-record inventories of homes for sale will delay a pickup in construction. Rising net exports, the result of stronger economic growth abroad and the significant declines in the U.S. dollar, will continue to add to GDP growth. However, with foreign economies not fully decoupled from the U.S. and showing their own signs of slowdown, net exports are also vulnerable.

* The Fed’s aggressive easing has lowered the funds rate by 325 basis points to 2% since last September. Amid considerable Fed anxiety over its inflation-fighting credibility and continued energy price increases, reflected in multiple dissents at recent meetings, the Fed is on hold for now. Market expects that continued below-trend GDP growth and a rising unemployment rate will eventually lead to modest additional easing, and project a 25-basis point ease to 1.75% at the September 16th FOMC meeting. Market expects Fed tightening to begin in mid-2009, once the unemployment rate has peaked and credit conditions substantially improved.