Rising cheer on US economy points to series of Fed rate rises

Impending tax cuts and buoyant markets underpin sunny outlook

An expected interest rate rise by the Federal Reserve this week will open the door to further increases in the new year as the prospect of tax cuts helps underpin an improving outlook for US growth, economists say.

In one of her last big moves as Fed chair, Janet Yellen is likely on Wednesday to preside over the third one quarter-point rate increase, taking the central bank’s target range to 1.25-1.5 per cent.  With tax legislation moving rapidly through Congress, Fed policymakers are also set to factor the impact of tax reductions into their forecasts for gross domestic product, after having previously pared back their expectations for fiscal stimulus.  “The reality is the economy is doing very well,” said Tim Duy, a Fed expert at the University of Oregon. He said factors including buoyant financial markets and the looming tax cut suggested more rate rises in the new year.

Analyst forecasts indicate the Republican tax package will have a modest impact on growth, with Goldman Sachs assuming a contribution of 0.3 percentage point in 2018 and 2019. But, with the US economy close to or even beyond full employment, global growth strengthening, and inflation showing tentative signs of firming, the short-term stimulus from tax reductions is likely to support arguments for further rate increases.

That marks a turnround from September, when most Fed officials were either not expecting a fiscal package to be approved books or had pared back their estimates of the growth impact.  “Next week’s economic forecasts are likely to show a lower unemployment rate than the September projections and a generally firmer outlook for GDP growth; both revisions should be directionally supportive of a somewhat faster rate normalisation path,” said Michael Feroli, US economist at JPMorgan Chase.

At 4.1 per cent, unemployment is already at levels not seen since the early 2000s and as low as the Fed was expecting at the end of next year.  Employers added another 228,000 workers in November, according to figures last week, more than enough to drive further declines in the jobless rate.

The Fed’s September forecasts pointed to three more rate increases in 2018, and a big question for Wednesday is whether policymakers stick with that outlook or pencil in more rises.  Ms Yellen is facing questioning on how the tax reforms are set to affect monetary policy when she gives her final scheduled press conference as Fed chair on Wednesday afternoon.

Recent signals from the Fed suggest punchy growth next year as well. Jay Powell, the nominee to take over from Ms Yellen, said last month he was predicting growth of up to 2.5 per cent this year and next.

The median outlook in the Fed’s last forecasting round in September was for growth of 2.4 per cent this year and 2.1 per cent in 2018. Adding further lift to the economy are elevated asset values, including surging stock prices.

The Federal Reserve Bank of Chicago’s index of financial conditions is close to its loosest levels since the mid-1990s. But the central bank has shied away from a quicker pace of rate rises because of disappointing inflation and lacklustre wage readings which have flummoxed policymakers for much of the year Mr Powell said in recent testimony that the US was not overheating, suggesting he was cautious about stepping up the pace of tightening.