The SA Daily
18 April 2018
Fed hikes are warranted
- In a previous edition of The SA Daily, we noted that at the peak of a business cycle, unemployment is at the so-called neutral rate of unemployment i.e. a non-inflationary level. At such a point, potential growth has been reached, and inflation pressures start to build, resulting in a need for tighter monetary policy in order to slow down demand.
- When the Fed started hiking rates in the current hiking cycle (2015), unemployment was clearly close to the neutral rate, and excess capacity in the US had begun to decline (i.e. operating close to potential GDP). However, excess capacity has since turned, and continues to grow, with the US economy now perhaps operating above potential GDP i.e. creating an inflationary gap.
- US capacity utilization data for March has come in at 78.0% y/y, from 77.7% y/y in February, broadly in line with expectations of 77.9% y/y. While there are some signs of a slowdown, it still implies that inflationary pressures building, while unemployment remains at 17-year lows. This supports our view for three further hikes by the Fed in 2018, with the next 25 bps hike in June. Fed fund futures are currently pricing a 91.5% probability of this.
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