US: Congress delivers another fiscal boost – Nomura

Analysts at Nomura explain that US congress passed a budget deal that will generate a significant increase in federal spending.

Key Quotes

“Breaking with historical precedence, Congress and the White House have opted to apply substantial fiscal impulse (through lower taxes and higher spending) to an economy near full employment and with an already bleak fiscal outlook.”

“The increase in spending is as important to our economic and Fed outlooks as the new tax law. However, the recent sell-off in in equity and credit markets somewhat dampens our outlook.”

“We now expect GDP to grow 3.0% in 2018 and 2.7% in 2019, with fiscal policy providing a significant boost to growth beginning in Q2 2018 through the first half of 2019. We expect the unemployment rate to fall to 3.2% by end-2019 (adjusted for demographic changes, the unemployment rate would be 0.1pp below the low reached in 2000). The stronger outlook also lifts our inflation forecasts modestly. We now expect core PCE inflation growth to rise to 2.1% (from 2.0% previously) on a 12-month basis by end-2019.”

“The tax and spending policies will worsen an already bleak fiscal outlook. Over fiscal years 2018 through 2020, fiscal policy will add an average of $300bn/year to annual deficits.”

“Leading the Fed’s response to these developments will be the first big challenge for Chair Powell. We now expect the Fed to hike four times this year, starting in March, and twice more in 2019, an additional hike in each year from our previous call.”

“Whether the FOMC shifts up its interest rate forecasts in March will depend, in part, on how markets evolve between now and then. From the Fed’s perspective some tightening of financial conditions is welcome to stem the continuing strength of the economy and labor markets and to cap upside risk to inflation. However, if markets remain volatile, the Fed may not signal that it expects a more aggressive path of rate increases.”

“Powell’s first scheduled public appearance on 28February will be both widely and closely monitored. Recent fiscal and financial developments only heighten the interest in his first public comments as Fed Chair.”