US growth suggests rates will rise to end of 2020

Recent growth figures for the US economy showed that its economic expansion slowed somewhat to 2.6% in the fourth quarter last year, from 3.2% in the previous quarter, writes John Fahey.

US growth suggests rates will rise to end of 2020

Recent growth figures for the US economy showed that its economic expansion slowed somewhat to 2.6% in the fourth quarter last year, from 3.2% in the previous quarter, writes John Fahey.

However, the underlying figures showed that despite slower headline growth, underlying economic activity strengthened, including a strong performance from consumer spending and business investment.

Overall, the economy increased 2.3% in 2017, an improvement on the previous year’s 1.5% increase.

Meanwhile, the first batch of labour market data for 2018, indicated that the economy continues to register strong jobs growth.

The non-farm payrolls data for January published last Friday surprised to the upside of expectations, registering a 200,000 gain in the month.

That follows the solid performance recorded in 2017.

And the unemployment rate held at 4.1%, its lowest level in 17 years.

Another encouraging aspect to last week’s raft of labour market figures was the earnings data.

US wage growth grew at a modest pace in 2017 despite the tightening conditions in the labour market.

However, average hourly earnings in January rose by a better-than- expected 2.9% on a year-on- year basis, its best rate of growth since 2009, suggesting that US wage growth may finally be starting to accelerate.

The outlook for the economy remains positive.

Business and consumer surveys suggest investment and consumption will continue to support growth.

Meantime, interest rates remain low, while stockmarkets have risen strongly over the past two years.

At the same time, the range of tax cuts passed by the US Congress at the end of last year should provide a further fillip to growth in the next couple of years.

The IMF estimated recently that the fiscal stimulus would provide a cumulative 1.2% boost to growth between this year and 2020.

The IMF is now forecasting growth in 2018 of 2.7%, compared with 2.3% previously, and 2.5% in 2019, up from 1.9% in an earlier forecast.

The IMF does highlight some risks to the economy too.

These include the possibility that the fiscal stimulus will increase the demand for imports, widening the current account deficit further.

The stimulus could put further pressure on the labour market, leading to higher inflation.

This may see the Federal Reserve hike rates more quickly or to a greater extent than markets currently expect, while it could also lead to a ‘correction’ in equity prices.

The protectionist stance of the president Donald Trump’s administration is also a risk to growth.

Nonetheless, the solid economic backdrop in the US enabled the Fed to hike interest rates three times in 2017, bring

the Fed funds rate to 1.375%.

Meantime, last week’s Fed policy meeting statement for January remained consistent with the consensus view that the Central Bank will raise rates again by 25 basis points in March.

The Fed is indicating that it will raise rates three times again this year, bringing rates to 2.125% by the end of 2018.

Market expectations have become more hawkish on the rate outlook over the past six months and the market is now broadly in line with the Fed’s guidance for this year.

This has been a key driver of US bond yields rising to multi-year highs recently, with the 10-year yield rising above 2.8% for the first time since early 2014.

However, the market is expecting very little in the way of additional Fed rate increases in 2019 and 2020.

This suggests that it is either anticipating inflation will remain subdued and/ or the economy will slow, resulting in the Fed being unable to raise rates much further.

Recent trends in US macro data, though, suggest that this is unlikely to be the case and thus further rate hikes would seem likely in 2019 to 2020.

John Fahey is a senior economist at AIB.

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