Analysts at Nomura believe the US late-cycle surge will continue through 2018, boosted especially by fiscal policy and they anticipate four hikes from the FOMC in 2018 and inflation to gradually climb higher.

Key Quotes

Economic activity: We expect the US economy to continue to grow significantly above potential in 2018 and 2019, boosted by tax cuts and a pick-up in government spending. Job gains remain well above the long-term sustainable pace and will likely continue to push down the unemployment rate to levels not seen since 2001. However, productivity growth remains soft, held down by structural declines in underlying business dynamism (e.g., the rate of new business formation and workers changing jobs). The lower dynamism also places downward pressure on wage growth.”

Inflation: Transitory factors that contributed to the weak inflation in 2017, such as prices of wireless telecom services and medical care commodities, have largely reverted. In 2018 and 2019, we expect core inflation to pick up gradually as labor markets tighten and the economy operates above potential. Core PCE inflation may pick up slightly faster than core CPI as healthcare service inflation could accelerate while rent inflation gradually slows. With upside risk to healthcare prices as well as expected further labor market tightening, we expect core PCE inflation to reach 2.3% in Q4 2019.”

Policy: Facing strong momentum in aggregate demand, tightening labor markets, and some evidence of a rebound in inflation, we look for the Fed to hike four times in 2018 and two more times in 2019. We think the roll-off of the Fed balance sheet will gradually raise long-term interest rates. We do not believe that new Fed leadership will cause a material change in the near-term trajectory of monetary policy.”

Risks: Financial conditions remain accommodative but recent market activity suggests they can turn quickly. The US and China escalated tit-for-tat threats of imposition of tariffs. At the moment, we continue to view these actions as opening positions for an eventual negotiated settlement between the US and China. However, the Trump administration’s aggressive stance raises the risk of a full-blown trade conflict between the two countries, in our view.”

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