What strong U.S. growth means for Fed rate hikes

Economic indicators point to a healthy year of growth for the U.S., but not necessarily to an increase in the pace of Fed rate hikes.

“A fifth consecutive quarter of above-2% real GDP growth is in the cards for the U.S. economy,” says National Bank economist Krishen Rangasamy in a monthly economics report, referring to potential results for Q2.

Read: U.S. Q1 growth slowed but still beat expectations

For example, consumer spending looks positive for the second quarter, based on April’s retail data, among other economic indicators.

“Consumers seem to be responding to still-low interest rates, easy access to credit, but also to the boost to disposable incomes provided by personal income tax cuts and a healthy labour market,” says Rangasamy.

In fact, real personal spending has rebounded at the fastest two-month pace in three-and-a-half years, says Sal Guatieri, BMO senior economist, in a weekly financial digest.

Further, business spending is “on an absolute tear,” he adds. Non-residential investment is up 9.2% in Q1, he says—also the fastest pace in three-and-a-half years.

Lack of sustained inflation

Though positive growth might result in some rising inflationary pressure over the near term, Rangasamy doesn’t expect U.S. monetary policy will become overly aggressive.

Read: Rising rates and dividend-paying stocks

For example, structural changes to wages, such as increased employer concentration, may help prevent sustained inflation at the Fed’s 2% target rate. (Fewer employers may result in low wage growth, according to research, says Rangasamy.)

Nor is the impact of higher oil prices likely to fuel sustained inflation. Rangasamy says that, unless inflation expectations also move up significantly, the oil-induced price boost to inflation will be temporary.

“A recent IMF study showed the impact of rising oil prices on U.S. inflation fading completely within three years of the initial [price] shock,” he says. “In other words, such price swings are unlikely to influence Fed policy.”

Another factor to weigh on the Fed is moderation in household debt accumulation. “The slowdown of household leveraging reflects rising interest rates but also tighter lending standards, particularly for mortgages and auto loans,” says Rangasamy. He notes that in the first quarter, one-third of auto loan origination—the highest share in seven years—and nearly 60% of mortgage origination went to borrowers with the highest credit scores.

The housing market’s recovery also warrants caution from the Fed, with homeownership rates below pre-recession levels across all demographics, he says, which curtails spending on durable goods.

“All told, while U.S. real GDP growth will likely be near 3% this year, i.e., well above potential, we expect the Fed to exercise restraint with no more than two additional interest rate hikes this year, including one in June,” says Rangasamy.

In the BMO report, deputy chief economist Michael Gregory offers a more technical analysis of U.S. inflation, and forecasts a 2.75% to 3% Fed funds target range by mid-2019.

The Fed maintained its rate at 1.5% to 1.75% in May after raising it in March. The next meeting will be held June 12 to 13.

For full details, read the reports from National Bank and BMO.

Also read:

What’s behind rising bond yields in Canada and U.S.

Tilting away from cyclicals: Are we there yet?

Recession a possibility by end of 2020: U.S. biz economists