Jefferies

Economics and Strategy

U.S. Outlook – 2018: The Baton Is Passed

— Ward McCarthy, Chief Financial Economist

With the enactment of tax reform, and as Jerome Powell assumes the mantle of leadership for monetary policy, 2018 will be marked by the passing of the baton from monetary policy to fiscal policy as the primary source of economic stimulus.

U.S. Economy Ended 2017 in a Good Place, Growth Profile to Continue to Improve

Consumer spending will be boosted by continued job growth, increased wealth, rising disposable income, and increased confidence.  Many, but not all households, will benefit from tax cuts, and increased disposable income.  

The cumulative effects of business deregulation and corporate tax relief will foster a more business-friendly environment.  Rebuilding housing stock in regions devastated by natural disasters will boost construction activity in a market that is already struggling with a shortage of construction workers.

An Acceleration in Inflation Lies Ahead

With six million job openings, tightening labor markets, and rising voluntary separations wages should accelerate in a more meaningful way.

The supply shock in housing caused by the natural disasters will accelerate the upward trend in the shelter component of the CPI.  In addition, the rising prices for imported goods will then get passed on to a stronger consumer sector that is able to absorb price increases, and inflation measures will also be boosted by supportive base effects. 

Monetary Policy Normalization to Accelerate, Composition of the Balance Sheet More of a Focus

We believe new Fed Chairman Jerome Powell will continue a monetary policy of gradual rate and balance sheet normalization.  The Fed should react to the stronger economy and fiscal stimulus with four rate hikes and continued balance sheet normalization that is pre-programmed to accelerate.

We also see Powell guiding a more tailored approach to financial deregulation that moves away from the one-size-fits-all post-crisis regulatory approach.

With the departure of Janet Yellen, Stanley Fischer, and Bill Dudley, there will be increased policy uncertainty until replacements are on board.  With the addition of Marvin Goodfriend to the Fed Board of Governors, however, the Fed has added a world-renowned monetary policy expert.

The composition of the Fed balance sheet—the lack of bill holdings and the slow MBS roll-offs—is likely to become a policy topic.  At some point in the year, the focus of balance sheet normalization will shift more to composition and the desire to increase Treasury bill holdings and decrease MBS holdings at a more accelerated pace.

“Tax Cuts & Jobs Act“ (TCJA)

The “Tax Cuts & Jobs Act“ (TCJA) is far from perfect but will create a more business-friendly environment and boost long-term growth in the US.  The consequences of the TCJA for the consumer sector are more ambiguous and mixed.  While tax cuts will increase disposable income for most households, the housing sector in high-tax states is at risk due to the SALT and mortgage caps. 

Many Downside Risks Emanating from Washington

The perpetually poisonous political environment in Washington will continue to generate uncertainty, frustration, a surplus of investigations, and a shortage of progress on important issues.  The evolution of protectionist policies could threaten global trade and adversely affect both growth and inflation.

Geopolitical risks and tensions will continue to provide an uneasy backdrop to a US economy that is otherwise in a happy place.  Additionally, the abrupt emergence of cyber currencies adds an elusive element of risk.