The U.S. economy has remained resilient through the first 11 months of this year. Stronger business investment and consumer sentiment have buoyed the world’s largest economy. Despite the absence of inflationary pressure, the strong economic performance should induce the Federal Reserve (Fed) to continue its steady pace of lifting interest rates.
Investment upbeat
Profits of U.S. corporates remain solid, representing 11% of the country’s GDP in the second quarter (see Chart 1). As a whole, overall corporate profits improved 4.8% YoY in the first half, with domestic industries and overseas businesses growing 3.3% and 11.5% YoY respectively. Such trends reflect the fact that that business performance at home and abroad has supported the stabilisation of economic growth.
In the global arena, no major economy is currently being challenged by a recession -- unlike the period in 2011/12 when a glimpse of recovery flashed and disappeared quickly . This can explain why global businesses have become notably more optimistic. As a result, gross domestic investment by the private sector in the U.S. jumped 3.1% YoY in the first three quarters. Given the optimism shared by a wide variety of businesses,[1] the positive economic trends should continue in the near term.
Robust jobs market
These positive business conditions have pumped up the U.S. jobs market.
The private sector added an average of some 162,000 jobs per month through October in 2017, only slightly lower than the 170,000 average in 2016 (see Chart 2). This, in our view, indicates that the job market has been very robust.
Meanwhile, the unemployment rate reached 4.1% in October, the lowest level since December 2000. Together with the fact that the gap between unemployment and job openings rates was the slimmest since the latter became available in December 2000 (see Chart 3), there is abundant evidence for the optimism that business are displaying.
Looking ahead
Given the encouraging performance in the first three quarters and the positive sentiment, the IMF’s GDP growth forecast of 2.2% for the U.S. economy is within reach.[2] For 2018, the IMF’s 2.3% growth forecast could also be achievable, as the employment market is projected to stay tight.
Private sector investment growth should stay positive in 2018, while more positive surprises may come from favourable changes to the federal tax code. While the U.S. administration has been pushing for tax reform, with lower corporate and individual income tax rates as top priorities, some more lobbying work will be needed before a tax reform package is likely to be endorsed by Congress. As such, the benefits and impact will hinge on the final package as well as the timing.
Government expenditure – which contracted 0.2% YoY through the first three quarters – may turn around and expand in 2018, partly because of the potentially higher federal expenditure on defence (see Chart 4). Currently standing at 3.9% of the country’s GDP, a rebound of defence expenditure to the average of 4.7% of aggregate GDP should warrant much support to the economy.[3]
On the monetary policy front, we recognise the fact that a spike in inflation earlier this year -- when PCE inflation broke the 2% mark temporarily in January and February 2017 -- was short-lived. Although we do not expect an abrupt reversal of such a trend, given the strong economic momentum driven by the sustained improvement in domestic demand, the Fed will lift the Fed Funds Rate by another 25 basis points for the third time this year in December.
For 2018 and beyond, with Jerome Powell – a member of the Board of Governors of the Fed since 2012 – taking the helm in 2018, a smooth transition and continuity of the Fed’s policy can be expected.
In his testimonial before the Senate’s Banking Committee on 28 November, Powell suggested that he expected interest rates “to rise somewhat further,” but added that “we must retain the flexibility to adjust our policies in response to economic development.” [4] This suggests that the Fed’s monetary policy should see negligible change.
Given such initial rhetoric, and assuming everything else being equal, the Fed may raise interest rate no more than twice in 2018. On the back of healthy profit growth, U.S. businesses should be able to absorb the steady rise of borrowing costs. More ideally, businesses may transfer such rising costs to customers, which will in turn induce higher inflation, pushing it closer to the Fed’s long-term target.
[1] Referring to the results of the Business Roundtable CEO Economic Outlook Index, Small Business Optimism Index conducted by National Federation of Independent Business, and Sentix Economic Indicator.
[2] IMF (October 2017) Seeking Sustainable Growth: Short-Term Recovery, Long-Term Challenges. World Economic Outlook.
[3] An additional US$508 billion per quarter as of 3Q2017.
[4] Highlights from Jerome Powell's Senate Testimony, WSJ
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