Fed Sight Far Sight
About the author:
- Author name:
- By Michael Knox
- Job title:
- Chief Economist and Director of Strategy
- Date posted:
- 21 March 2017, 1:23 PM
After the meeting of the Open Market Committee of the Federal Reserve on 15 March, the Fed released its Summary of Economic Projections. These are the economic estimates provided by the Members of the Open Market Committee, plus all the Fed presidents, including those who are not voting at this meeting.
The median level of these estimates is shown in Table 1 below. The estimates include GDP growth; the level of unemployment; inflation (based on the personal consumption deflator); core inflation (based on the personal consumption deflator); and the Fed Funds rate.
The Fed thinks that GDP will grow at 2.1% in 2017. Last December, they thought the growth rate would be only 2%. The Fed also thinks that the growth rate in 2018 will be 2.1%. This is also up from 2% in December. They think that growth will slow in 2019 to 1.9% and in the longer term real GDP growth will fall to 1.8% p.a.
Higher growth means lower unemployment. The Fed thinks that unemployment will drift down from 4.7% now to 4.5% in 2017. They think it will stabilise at 4.5% in 2018 and 2019. In the longer run, they think it will drift up to 4.7%.
As growth improves, so does inflation. The Fed thinks that inflation will rise from 1.9% in 2017 to 2.0% in 2018. They think that inflation will stay at 2.0% in 2019 and in the longer term. The outlook for core inflation is pretty much the same as headline inflation. Interestingly, they provide no core inflation estimate for the longer run.
The reason that growth accelerates and then slows is because the Fed is continuing to increase the Fed funds rate as time goes by. The Fed thinks there will be three Fed rate hikes in 2017. They think there will be a further three Fed rate hikes in 2018. In 2019 the Fed sees the Fed Funds rate going up by 90 basis points. This is more than three rate hikes but not quite four. By the time this process is over at the end of 2019, the Fed Funds will have achieved the Feds long term target of 3.0%.
A bridge too near
We think that the Fed's pace of interest rate hikes is too slow. This pace is not a bridge too far but a bridge too near. The US economy will grow faster than the Fed thinks. We think that investment in the US economy is recovering faster than the Fed believes. This is at least in part because of the greater level of business confidence generated by the Trump Administration. We think that US GDP will grow by 2.3% in calendar 2017. We think that US GDP will grow by 2.6% in 2018. This means that the actual growth rate by the end of 2018 will be 0.7% of GDP greater than the Fed believes. Instead of unemployment at 4.5%, the Fed could be looking at unemployment between 4.0% and 3.8%.
This very low level of unemployment has previously set the limit of growth in the US economy. At this low level of unemployment there are no longer enough qualified people in the US labour market to support further growth. The result of this has previously been a rapid acceleration of wages growth and rapid acceleration of core inflation.
The result of this faster growth and lower unemployment (than the Fed expects), will be that the Fed will be moving faster to increase interest rates.
Conclusion
We expect that the Fed will increased the Fed Funds rate every quarter for the next two and a half years. We agree that the Fed funds rate will eventually hit a target of 3.0%. We think this target will be reached in mid 2019, not late 2019.
More information
View more analysis by Michael Knox by clicking on 'economic strategy' in the popular topics list to the right of this page.
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