Jay Powell Takes the Helm at the Fed as U.S. Economy Enjoys a Tailwind
U.S. economic momentum was good through 2017 and may be better in 2018. Real GDP growth increased through the first three quarters of 2017, reaching a 3.2 percent annualized rate in 2017Q3. Real GDP growth then eased a little in 2017Q4, to a 2.6 percent annualized rate. Three key factors that pushed and pulled on GDP growth in 2017Q4 may be reversing themselves in 2018Q1, and this could lead to a stronger growth in the current first quarter. Real consumer spending was a positive in 2017Q4 as consumers, many from hurricane ravaged Texas and Florida, bought new cars and trucks. We expect the push from consumer spending on durable goods will ease significantly in 2018Q1. We have already seen unit auto sales throttle down from a 17.9 million unit rate last December, to a 17.2 million unit rate in January. Auto sales could ease further in the months ahead. However, even as consumer spending was strong in Q4, adding to GDP growth, both inventories and net trade were weak, together pulling nearly 2 percentage points off of Q4 real GDP growth. Those two key levers could reverse in early 2018, pushing real GDP growth in 2018Q1 back above 3 percent despite the drag from cooler auto sales. Average real GDP growth for 2017Q4 and 2018Q1 could push back above 3 percent, expending the run of solid GDP growth from 2017 into 2018.
Jay Powell was sworn in on February 5th as the new Chairman of the Federal Reserve. His comments after the ceremony were brief but positive, highlighting the current strength of the U.S. economy and of the U.S. financial system. The Powell Fed faces the challenge of appropriately communicating and executing Federal Reserve interest rate strategy at a time when inflation-related metrics are sending mixed signals. The January employment report showed that wages are warming up. Higher wages tend to put pressure on corporations to increase their prices, stoking higher inflation. However, the Fed’s favored measure of inflation, the trimmed mean PCE price index, has been running consistently below the Fed’s symmetric near-2-percent inflation target for the past several years.
The Powell Fed is also expected to increase the amount of maturing assets that it will allow to roll off the balancing sheet, in line with the schedule announced last summer. This will put marginal upward pressure on interest rates along with the push from an increasing fed funds rate.
Powell’s first meeting as Chairman of the Federal Open Market Committee, scheduled over March 20/21, will be an interesting one. Financial markets currently expect another fed funds rate hike on March 21, to a range of 1.5-1.75 percent. The fed funds futures market shows that the implied probability of a March 21 rate hike is about 78 percent. The Fed’s last dot plot, from December 13, 2017, is consistent with thee rate hikes in 2018. This could result in a pattern of a rate hike every other FOMC meeting, March, June and September, and then a pause at the end of the year. The cumulative implied probability of a second rate hike on June 13 now stands at a fairly high 60 percent. The cumulative implied probability of a third rate hike on September 26 stands at a not-insignificant 39 percent.
However, if the Fed is concerned about increasing inflation and increasing inflationary pressure coming from higher wages, it may not make sense to raise rates three times in 2018 and then pause for four months, from the end of September through the end of January, before raising rates again in January 2019. So, we look forward to seeing the new version of the Fed’s dot plot on March 21 to see if it gets steeper than the last dot plot from December 2017. A steeper dot plot could imply a total of four rate hikes in 2018 and not three. It could also imply a higher peak value for the fed funds rate in this business cycle.
For a PDF version of this report click here: USEconomicOutlook_0218.
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