US in 2H17: The Fed’s ongoing dilemma
US’ advance estimate for the second quarter (2Q) gross domestic product (GDP) showed that the economy grew at a 2.6 per cent annualised pace during the quarter.
Growth was supported by private consumption, which rose 2.8 per cent, and by non-residential fixed investment, which added 0.6 percentage points to US’ GDP.
The rebound in activity was less than many expected heading into the quarter.
We see that some of the shortfalls relative to consensus’ expectations stemmed from motor vehicles consumption, which declined 1.8 per cent.
Elsewhere, and against our expectations, net trade grew for the second consecutive quarter, appearing buoyant – and synchronised – with economic activity outside the US combined with the decline in the foreign exchange value of the dollar since year-end which lifted exports.
For the second half of the year (2H17), we expect US to grow between two to 2.5 per cent, which would leave the economic performance in 2017 with little change from the previous years.
The GDP data, including revisions back to 2014, showed that the US economy continued to deliver modest activity growth.
The lack of progress on the fiscal policy reforms, including the failure of reforming the country’s health care system last week, suggests that the economy will likely stay in this modest growth environment for the remainder of this year.
There is little activities or developments on the policy front which could suggest the Fed needed to accelerate its normalisation plans. Gradual normalisation of the monetary policy stance remains the most likely outcome.
Based on what we can deduce from the current balance sheet policy, we believe that this points to a catalytic announcement at the Fed’s September meeting.
The committee stated that “for the time being”, it continues to reinvest principal payments from its securities holdings, but “expects to begin implementing its balance sheet normalisation programme relatively soon” (versus “this year” previously).
While the use of “soon” might be more appropriate given the committee’s desire to begin shrinking the balance sheet, “relatively soon” provides flexibility to delay any announcement should the debt ceiling, or other fiscal policy concerns, rattle markets ahead of the September meeting.
We see this as a low outcome and during the inter-meeting period, we expect the Federal Open Market Committee (FOMC) to signal that there is a change in the balance sheet.
If anything, the recent weakness in inflation suggests the opposite may be true.
However, we believe that the Fed is committed to moving the stance of monetary policy closer to neutral with respect to the level of activity and inflation.
It is also likely to remain patient when assessing incoming data on inflation.
In its statement following the July meeting, the Fed did soften its description of inflation, saying that headline and core inflation are running “below” two per cent, as opposed to “somewhat below” during the June meeting.
Further down in the statement, however, it did not alter its forward-looking assessment that the inflation would likely return to the two per cent target over the medium term. We do not read this as a major softening in view or a change in reaction.
Instead, we see it as the committee’s way of facing facts on where the inflation is currently at.
The committee expects the inflation to be subdued through early next year, due to what it sees as negative base effects from transitory factors.
We believe it will be patient as it evaluates underlying inflation trends.In regards to the policy path, we still see the Fed as eager to get in another rate hike this year in December.
Any alteration in the policy path from inflation underperformance is more a risk for 2018 than 2017, in our view on the forthcoming policy.