North America The US: Fit for a marathon

5 min
Dan North
Dan North Senior Economist for North America
Alexis Garatti
Alexis Garatti Head of Macroeconomic Research

The American economy is set to benefit in 2018 from one of its longest cycles of expansion amid a favorable policy-mix

US economy to be more balanced

The US economy registered a stronger than expected level of growth in Q3 17 at 3.2% (q/q annualized). This happened on the back of  higher contribution of net exports and investment, while consumption decelerated a bit after a remarkable period of stability.

This configuration is promising, as it taps into  more diversified sources of growth. Thus, we see  a more versatile allocation of  the benefits of what is now the second longest cycle of expansion.

A better balance of different contributors to growth will be the key theme for 2018.  We expect the US economy to accelerate and grow by 2.6% y/y against 2.3% y/y in 2017.

Household consumption will climb broadly at the same pace as in 2017 at 2.6% y/y amid steady progress on the job front and  higher wages. These would be counterbalanced by higher inflation and weaker growth in consumer credit. Investment will register the most significant improvement thanks to the boost provided by the Tax Cuts and Jobs Act (TCJA). 

Non residential investment will reach 5% on a y/y basis in 2018 compared with 4.4% y/y in 2017. Residential investment is also expected to accelerate albeit in a more muted manner as TCJA is not really judged as being supportive of the housing market.

TCJA to further tighten job market 

A late positioning in the cycle, limited redistribution effects (wealthy households are expected to benefit the most from individual tax cuts), a limited impact of tax repatriation initiative and the priority given to reducing taxes on corporate profits suggest a limited multiplier effect of the TCJA.

In our view, the most significant effect of the Act, beside the temporary boost to  growth (estimated at +0.5% in 2018), should appear in the job market.

This would take place  via higher wages expected at 3% y/y on average in 2018 against 2.5% y/y in 2017, as unemployment will decline to 3.5% ( from 4.1% today.) 

The Fed to hike 3 times in 2018

Despite a lower degree of slack in the economy, the Fed won’t be in a hurry to hike the Fed Funds Target rate. CPI inflation is estimated to rise by a mere 2.2% y/y in2018 compared to 2.1% y/y in 2017.  We expect three hikes in 2018 with the first move to take place in March.

Chart 1 US macro forecast (contribution to growth, %, YoY)

Sources: IHS, Euler Hermes, Allianz Research

The Federal Reserve will see significant personnel changes in 2018 as Jerome Powell replaces Janet Yellen, Randall Quarles replaces Daniel Tarullo as supervisory chief, and New York Fed President William Dudley is to retire in mid-2018. Then  there are still two vacant positions. 

These moves  will incentivize the Fed to establish its credibility by sticking to the well-communicated plan of three hikes in 2018.

The stock market, already over-stretched in terms of valuation, would thus not face any surprises from the Fed’s side. 

Canada : Solid but risky

The Canadian economy was among the strongest in the developed world in 2017, with GDP growth of about 3.1%. However, base effects will cause the economy to slow in 2018 and return to grow closer to its sustainable potential at 2.3%.

The white-hot labor market will underpin that growth. Unemployment is at a record low 5.7%, and the economy added a total of 159,000 jobs in November and December, at three times the rate of the U.S. The recent rise in oil prices will serve as another boost at least in Q1.

The Bank of Canada has responded, raising the policy overnight rate twice in less than two months in 2017, once so far in 2018, and probably twice more in 2018, helping keep inflation under 2%. However two serious risks remain. Negotiations over NAFTA, which are due to end in Q1, have been contentious. A collapse of NAFTA, which once seemed unlikely, has now evolved into a possibility.

If it were to happen, the Canadian economy would suffer massive damage. In addition, the housing market continues to pose a risk, as government measures to slow bubble-like price increases have caused sharp swings in activity. Prices fell 7% in Toronto in just four months. Unit sales nationwide fell 10% between Q1 and Q3, but have recovered significantly since then. Overall 2018 looks to be a strong year, but the risks are high.