Latest data show strengthening economy, set stage for rate hikes
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The January inflation numbers are in. With Consumer Price Index (CPI) registering at 2.5 percent and the Personal Consumption Expenditure (PCE) index registering at 1.9 percent, we are now circling the Fed’s long-term target inflation rate of 2 percent.

Other macroeconomic indicators are also looking strong. The unemployment rate is 4.8 percent, which is at the median Federal Open Market Committee (FOMC) participant estimate of the longer-run normal rate of unemployment.

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Manufacturing activity continues to grow. The Institute of Supply Management's Purchasing Managers’ Indexes (ISM PMI) reached 57.7 percent in February, the highest reading since August 2012. The stock market continues to climb, with the Dow, S&P 500 and Nasdaq Composite Index all reaching new all-time closing highs. 

 

Things are also looking up globally, as well. Euro area inflation reached 1.8 percent in January and Germany’s CPI even increased to 2.2 percent in February — its highest level in four years. Manufacturing is also accelerating in the Euro area with PMI reaching 55.4 in February, increasing for six months in a row. Major Asian economies — China, Japan and South Korea — also saw manufacturing activity accelerate last month.

The Fed governors, both hawks and doves, have also voiced their support for monetary policy tightening. New York Fed President William Dudley, San Francisco Fed President John Williams, Dallas Fed President Robert Kaplan and even the Fed Board of Governors' Lael Brainard — a notorious dove — have spoken out for increasing interest rates soon.

Brainard also spoke about normalizing monetary policy, where short-term interest rate change is restored as the primary policy tool and the Fed balance sheet is gradually reduced. President Trump’s speech to the joint session of Congress on Tuesday had no surprises, and now, even investors are becoming convinced of liftoff, with market expectations of a March rate hike at nearly 70 percent. 

While it looks almost like a sure thing, the March rate hike is a small step in the larger scheme of our economy. We will need continued growth in wages and consumption, and, more crucially, businesses’ and consumers’ expectations will need to be met to keep the economy going. How do we do this? 

Despite the rosy picture, there is evidence that more needs to be done to support demand. Growth in consumer spending has actually slowed to 0.2 percent from 0.5 percent in December. Real consumer spending even fell 0.3 percent. Business investment started to increase — spending on equipment increased 3.1 percent in the fourth quarter of 2016 — for the first time in over a year, while investment in non-residential structures fell by 5 percent. 

President Trump reiterated his plans to the joint session of Congress, which include a $1 trillion investment in infrastructure through public and private capital and tax cuts for American businesses and the middle class. 

Business and consumer confidence are high for now. For that to remain the case, which would spur further investment and consumption leading to stronger economic growth, Americans need concrete details from the administration on the president’s plans and strong leadership to make them happen.

If they are able to do so, we might be in a happy position next quarter, discussing the next rate hike with the backdrop of a strong economy. The ball is in the administration’s court.

 

Sumit Agarwal is William G. Droms Term Professor of Finance at Georgetown University’ McDonough School of Business. For more information on Agarwal, visit www.ushakrisna.com. 


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