U.S. GDP growth expected to remain strong in Q4
U.S. durable goods orders expected to show continued strength
ECB may defer guidance tweak until June
Little chance of a FOMC rate hike next week
U.S. GDP growth expected to remain strong in Q4 — The market consensus is for today’s U.S. Q4 real GDP report to show another strong gain of +3.0%, a bit below Q3’s +3.2% pace. Today’s Q4 personal consumption report is expected to be even stronger at +3.7% (vs Q3’s +2.2%), illustrating the strong holiday shopping as well as increased post-hurricane purchases.
The Atlanta Fed’s GDPNow Q4 GDP forecast of +3.4% stems from strength in personal consumption (expected contribution to GDP of +2.73 points), business investment (+1.21 points), and government spending (+0.48 points). GDPNow expects some offsetting subtractions from net exports (-0.60 points) and inventories (-0.42 points).
U.S. GDP growth near +3.0% in the last three quarters of 2017 represents a very good performance for the U.S. economy. The recent growth rate near 3% is substantially better than (1) the tepid +2.2% average growth rate seen since the Great Recession, and (2) the Fed’s view of a longer-run U.S. growth potential of only +1.8%.
On a calendar year basis, the consensus is that U.S. GDP growth in 2018 will pick up to +2.6% from +2.3% in 2017 due to the tax cuts and strong global growth. However, the consensus is that GDP growth will then fall back to +2.2% in 2019 after the tax-cut effects start to wear off.
U.S. durable goods orders expected to show continued strength — The market consensus is for today’s Dec durable goods orders report to show a solid increase of +0.8% and +0.6% ex-transportation following Nov’s report of +1.3% and -0.1% ex-transportation. Dec core capital goods orders (ex defense and aircraft) are expected to show an increase of +0.6% following Nov’s disappointing report of -0.2%.
Durable goods orders in November were strong with a year-on-year increase of +8.2% y/y (+7.1% ex-transportation). Moreover, durable goods orders in early 2018 should remain strong due to (1) increased investment by businesses that have extra cash after the tax cuts, and (2) continued strong overseas sales prospects due to the strong global economy and the weak dollar.
Confidence in the manufacturing sector is strong with the ISM index in December rising +1.5 points to 59.7, which is just below the 13-1/2 year high of 60.8 posted in Sep 2017. Moreover, the ISM manufacturing new orders sub-index is even stronger with a sharp +5.4 point increase in December to a new 14-year high of 69.4. The 14-year high in confidence about manufacturing orders shows that the manufacturing sector is seeing strong order flow that should soon translate into stronger production and shipments.
ECB may defer guidance tweak until June — The ECB at its meeting on Thursday left its policy rates, QE program, and guidance unchanged, in line with market expectations. However, EUR/USD surged to a 3-year high after ECB President Draghi in his post-meeting press conference voiced little concern about the euro’s strength and said improving economic momentum has “strengthened further our confidence that inflation will converge to close to but below 2%.†EUR/USD fell back from its best level after Draghi said he sees “very few chances†that interest rates will be raised this year. EUR/USD also fell back after President Trump said he supports a strong dollar, trying to walk back Treasury Secretary Mnuchin’s comments on Wednesday that the short-term weakness in the dollar does not cause him any concern.
EUR/USD was then undercut later in the day when Bloomberg reported that some ECB officials prefer June for a hawkish guidance shift rather than the current market expectation of March. Going into this week’s meeting, the market consensus was that the ECB would shift its QE guidance at its March meeting, announce in July a definitive end point for QE, and end the QE program by December.
A delay in the guidance shift until June would give the ECB more time to see if inflation is moving up towards its target of just below +2%. A delay in the guidance shift would also have the benefit of curbing the euro’s strength. The surge in the euro is disinflationary and is therefore working at cross-purposes with the ECB’s goal of pushing inflation up towards 2%. The ECB in its guidance shift is expected to sever the strong dependency on inflation for determining when QE will end, thus allowing the ECB to end QE earlier.
Little chance of a FOMC rate hike next week — The federal funds futures market is discounting only a 20% chance that the FOMC next week will raise its funds rate target by another +25 bp. The FOMC just raised its funds rate target range by +25 bp to 1.25-1.50% at its last meeting on Dec 12-13, meaning it would be too soon for another rate hike. However, the market is discounting a 100% chance for the first +25 bp rate hike of the year at the next meeting on March 20-21.
The market is discounting an overall +62.5 bp rate hike in 2018, which amounts to about 2-1/2 rate hikes. That is still mildly more dovish than the Fed-dot prediction for three rate hikes in 2018.
We fully expect the FOMC to implement three +25 bp rate hikes in 2018, which would push the funds rate target up to +2.00-2.25%. At that level, the funds rate would be slightly above the Fed’s +2% inflation target and inflation expectations near +2%, which would mean that the FOMC after roughly a decade would have finally done away with a negative real federal funds rate. Once the funds rate is above 2.00%, then the FOMC can take more time on deciding when to push the funds rate up towards its eventual target of 2.75-3.00% without causing a recession.