US: Economy to continue to grow slightly above potential - Nomura

According to analysts at Nomura, the next Fed rate hike expected in December will hinge on the progress of US inflation, labor market strength and financial conditions and expect a Fed Chair nomination in late October or early November.

Key Quotes

“Economic activity: We expect the US economy to continue to grow slightly above potential. Consumer spending has been growing steadily and investment has picked up from 2016. Despite the temporary hurricane impact, job gains remain strong, above the sustainable pace, pushing down the unemployment rate to levels not seen since 2001. However, productivity growth in H1 averaged an anemic 0.8%, held down by structural declines in underlying business dynamism (e.g., the rate of new business formation, churn within existing firms, and workers changing jobs). We expect these declines to weigh on wage growth. Moreover, we think that a tax bill will be passed in Q1 2018 that cuts taxes for individuals. We expect a $1trn package, although there is some upside risk. While we estimate this will boost Q1 GDP by 12bp, primarily in PCE, the boost will likely fade over the medium term.” 

“Inflation: Transitory factors that contributed to recent weak inflation, such as prices of wireless telecom services and medical care commodities, largely reverted. However, the recent hurricanes have increased uncertainty on near-term core inflation and could boost prices of new and used cars and rents. In 2018 and 2019, we expect core inflation to pick up gradually as labor markets tighten and the economy operates modestly above potential. Core PCE inflation may gradually pick up slightly faster than core CPI as healthcare service inflation accelerates while rent inflation gradually slows.”

“Policy: We expect the FOMC to continue on its gradual policy accommodation removal by raising short-term interest rates again in December and reducing its balance sheet starting in October. We expect the White House to announce the Fed Chair nominee in the coming weeks, but it could be delayed to early November. Who President Trump will ultimately choose remains highly uncertain. We do not expect the next Chair, no matter who it is, to change the course of policy – for rates and the balance sheet – in the near term. The changes will likely play out over years, not months.”

“Risks: Financial conditions have eased considerably but they could turn quickly in response to an external geopolitical event. The Trump administration could pursue more aggressive trade policies that could result in retaliatory actions by trading partners.”