U.S. full year 2018 growth forecast to be 2.7 pct y/y, says ING Bank

The US economy is going from strength to strength. GDP growth recorded its second consecutive quarterly 3 percent+ reading, key business surveys are at decade highs and unemployment at 16-year lows so there is a lot to be positive about. With external demand also strengthening we have revised up our full year 2018 growth forecast to 2.7 percent y/y.

This is more likely to be a late 2018-19 story. At the same time, there are tentative signs that inflation is starting to rise after having slowed through much of 2017. This is primarily a commodity story right now, but the lagged effects of dollar weakness and evidence of rising wages is giving markets greater confidence that the Fed is right to assert that inflation will soon return to its 2 percent target, ING Bank reported.

These factors alone argue in favor of a December interest rate hike. Nonetheless, the Federal Reserve is broadening out the reasoning for tighter monetary policy, citing relatively loose financial conditions (softer dollar and fairly flat yield curve) whilst warning that “persistently easy monetary conditions” might have “adverse implications for financial stability”. Caution over “somewhat rich” asset valuations also suggest an appetite for tighter monetary policy.

Assuming this situation doesn’t materialize, the path of Fed policy next year is looking a little clearer now that Jerome Powell has formally been announced as President Trump’s choice to take over from Janet Yellen. Yellen was reluctant to embrace Trump’s vision of loosening financial regulation to boost lending and growth prospects.

In terms of monetary policy Powell appears to be very similar to Yellen in both thinking and voting. So from a policy perspective, the directives from the Fed’s leadership are unlikely to alter markedly. He has never dissented at the FOMC meetings and is fully on board with the “gradual” increases in the Fed funds rate and the balance sheet shrinkage strategy.

"Under the leadership of Powell, we expect two more 25 bps Fed rate hikes in 2018 rather than the three the Fed have currently penciled in. This is mainly down to the Fed’s balance sheet reduction strategy doing some of the heavy liftings to tighten financial conditions, reducing the need for hikes at the short-end of the curve. However, the balance of risks are skewed to more, not fewer hikes", the report said.

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