Based on a mix of supportive economic policies and positive market conditions, the second half of 2018 seems to be positioned for growth in the United States. But acceleration is never a sure thing despite what may appear to be an environment ripe for spending.
US economic growth appears to be poised to accelerate in the second half of 2018, but the end of the economic cycle may be closer than anticipated by the consensus forecast. A pro-growth mix of economic policies has set conditions conducive to more rapid increases in consumer spending, business investment and labour compensation. Consumer spending is brisk and measures of business optimism seem to break records every month.
Capital spending plans
Investment plans have improved markedly since mid-2016
Sources: Morgan Stanley Research; Allianz Global Investors. Data as at 29 May 2018.
Past performance is no guarantee of future results.
Looking ahead to the second half of 2018, however, these outcomes cannot be assured despite their great promise. Households and businesses may well rethink their spending plans over the months ahead as they soberly evaluate the meaning of tax changes, government spending, economic policy adjustments and new risks to their well-being. If capital expenditures by businesses go to unproductive investment, productivity fails to accelerate and inflation-adjusted workers’ compensation does not increase, real economic growth could languish.
To be sure, Federal Reserve monetary policymakers will continue to base their interest-rate decisions on the flow of inflation, wage and labour market data. Yet how the Fed implements monetary policy over the next couple of years may be at least as important as the timing and magnitude of its policy decisions. Analysts to whom the Fed pays attention recommend that policy adjustments should focus increasingly on balance-sheet normalisation rather than policy-rate increases. A revised approach would hasten shrinkage of the Fed’s holdings of mortgage-backed securities with an eye towards their elimination within just a few years. Doing so would add precision and flexibility to policy implementation while also extricating the central bank from political pressures and a de facto fiscal policy role.
Nonetheless, if the Fed continues to make increases in policy interest rates the focal point of monetary policy implementation, fixed-income investors may have something to cheer. The reason is simple: over time, yield, not the change in yield, drives returns. Therefore, as rates rise, the total return to fixed-income securities tends to rise, not fall, with them.
Meanwhile, Congress and President Donald Trump's administration continue to implement a pro-business fiscal mix while also skirting around the letter and the intent of the legislated federal budget process. Fiscal policy likely will continue to reflect fractious political posturing devoid of critical details rather than well-reasoned, thoroughly debated bills. Henceforth, overall outlay and revenue decisions can be expected to take place in broad strokes of political expediency and with little regard for details. The appropriations process legislated into law in 1974 may well be defunct.
While the economic policy-making processes twist and turn, the interconnectedness of the US economy to others remains intricate and deep. Even as trade relations deteriorate, the forces of globalisation and technological revolution promise to defeat the forces of nationalism, populism and withdrawal from multilateral arrangements. Even if US-China and US-EU trade relations play out acrimoniously over the years ahead, for example, a complicated and extensive flow of goods, services, resources and intellectual property between the two nations will continue based, for the time being, on a co-dependency built up over the last three decades. In an interconnected world, developments anywhere can reverberate in anyone’s hometown.
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With the July meetings of both the ECB and the Fed on the horizon, we expect a quiet month for monetary policy, with little chance of surprises. We continue to expect two more hikes from the Fed in 2018, while the timing of the first rate hike from the ECB will be a critical milestone for markets.