UNITED STATES — The US economy is showing moderate growth averaging around 2¼% y/y heading into year-end. While the latest reports have been somewhat mixed, consumer spending and housing activity remain well supported by pent-up demand, a robust job market, rising income gains, solid household balance sheets, cheap gasoline prices, and low borrowing costs. Ongoing hiring gains, led by construction and services, have pushed the unemployment rate to a seven-year low of 5.0%, and alternative measures of labour market underutilization continue to improve. Consumer confidence has softened a bit in recent months, but remains relatively firm, and buying intentions are still solid. Motor vehicle sales are running at their strongest pace since early 2000.
A gradual easing in lending conditions, low mortgage rates and strengthening household formation are underpinning home sales and residential construction, though affordability pressures are beginning to emerge. Non-residential construction is showing broad strength across industrial and commercial sectors. The overall momentum in industrial activity remains soft amid the retrenchment in oil & gas drilling, inventory readjustments and sluggish export sales. US dollar strength and moderate global growth are weighing on export activity, though solid domestic sales should maintain expanding manufacturing production, led by motor vehicles, home furnishings, and consumer electronics.
A pickup in capital goods orders in September and October point to a firming in business investment intentions. Services activity is reporting broad-based expansion across a range of industries, including real estate, finance, utilities, and wholesale and retail trade. The US economy is also getting a lift from a pickup in local and state government spending, and a reduced pace of federal fiscal restraint. Core inflation is holding steady at just under 2% y/y, with lower import costs tempered by firmer services price trends. Headline US inflation appears to be bottoming, and is expected to drift back toward core inflation in 2016.
I expect that the Federal Reserve will increase the Federal Funds Rate at the December 16th FOMC meeting, raising the target range to 0.25-0.50% from 0-0.25% presently. We expect that Interest on Excess Reserves will be increased to 0.50% and the Reverse Repo Rate will be increased to 0.25%. Moving forward, we anticipate four 25 bps increases to the Federal Funds Rate and related policy rates in 2016, although we would highlight that there are risks both that the pace of rate increases could be slower than expected, or that rising US inflation and economic growth leads to more hikes than expected. One of the major questions regarding US monetary policy relates to the Federal Reserve’s balance sheet: when, if at all, will the Fed cease the reinvestment of maturing MBS and eventually Treasury securities? This will be a key question moving forward for US monetary policymakers. We do not expect it to be answered at the December FOMC meeting.