US economy to continue to grow slightly above potential - Nomura

Analysts at Nomura expect the Fed’s next rate hike to be in December as the labor market continues to strengthen and financial conditions remain very accommodative. 

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 has been soft, 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 down wage growth.
• On tax reform, significant challenges remain and the legislative calendar is crowded. Thus, we maintain a probability of 60% of a simple tax package passing in Q1 2018, focusing on personal income tax cuts; 20% of full-scale reform (similar to what the House and Senate are currently proposing), and 20% of no tax package passing at all. We estimate the expected simple package will boost Q1 GDP modestly, which will likely fade over the medium term.” 

“Inflation: Transitory factors that contributed to the 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 could accelerate while rent inflation gradually slows.”

“Policy: We expect the FOMC to continue to gradually pull back on policy accommodation by raising short-term interest rates again in December. We expect rolloff of the Fed balance sheet to raise long-term interest rates only gradually. President Trump’s decision to nominate Governor Powell as the next Fed Chair signals likely continuity of current interest rate and balance sheet policy, at least for some time.”

“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.”