HIGHLIGHTS OF THE WEEK
- Our outlook for the U.S. economy through 2019 got revised up this week, as additional fiscal stimulus helps boost the outlook for domestic demand growth.
- The inflation reading for February remains consistent with the view that price pressures are gradually building.
- The sunny outlook is not without downside risks. Higher interest rates have a tendency to expose vulnerabilities, and the threat of a global trade war is becoming more real.
Economic Boom to Last Through 2019
This week we released our updated quarterly forecast for the U.S. and global economy. Our outlook for the U.S. economy was revised up relative to our December forecast, as the federal budget bill passed by Congress in February adds more stimulus to an economy that is already running hot. Underlying this improved outlook is a view that domestic demand will grow more strongly, supported by fiscal stimulus. Personal income tax cuts provide a lift to disposable income growth and consumer spending, while corporate tax reform and the boost to federal spending should translate into stronger business investment.
With economic growth expected to average close to 3% over the remainder of this year, capacity pressures are expected to build. Not only should this incent firms to invest, but scarcer labor should support wage growth. Our outlook anticipates that underlying inflation in the U.S. will hit the Fed’s target of 2.0% before the end of the year, and stay slightly above target through 2019 (Chart 1). The CPI data for February supports this view, as price pressures ticked up a touch. Headline inflation rose to 2.2% y/y (+0.1 from 2.1% in January), while core inflation held at a 1.8% y/y pace.
After February’s consensus-busting job gains of 313k, we anticipate monthly job gains of 200k in upcoming months, roughly in line with its average since the Great Recession’s end. This should push the unemployment rate, which already sits at an eighteen-year low of 4.1%, even lower, reaching 3.7% by the end of 2019. Moreover, rising wages should encourage greater labor force participation enough to offset the drag from population aging.
In contrast to the very strong medium-term outlook, the outlook for the first quarter of 2018 is somewhat weaker. Retail sales in the first two months of this year have disappointed expectations, suggesting much softer consumer spending in the first quarter than the 3.8% (annualized) growth recorded at the end of 2017. We anticipate spending growth to re-accelerate in the second quarter, supported by the receipt of tax refunds, strengthening wage growth, and reduced personal income tax rates.
Booming economic activity together with building price pressures suggest that the Federal Reserve is likely to continue to raise interest rates this year and next. With three rate hikes on tap this year, the upper end of the range of the Fed’s policy rate should rise to 2.25% by year end. Moreover, better growth for 2019 suggests an additional 75bps of rate hikes, bringing the upper end of the range to 3.0% at the end of 2019.
This largely sunny outlook for the U.S. and global economy is not all blue skies. For one, higher interest rates have a tendency to expose vulnerabilities as firms and households spend more of their income on borrowing costs. While years of deleveraging have left U.S. households in good stead to handle higher rates, corporate debt has outpaced GDP growth in recent years. Lastly, the U.S. administration’s imposition of steel and aluminum tariffs and rumored forthcoming broad action against Chinese imports is a sign that global trade disruptions are more likely than previously appreciated (Chart 2).
Fotios Raptis, Senior Economist 416-982 2556
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