This month’s equity correction started after higher-than-expected US wage growth sparked fears of higher inflation and faster monetary tightening. On 22 February, US Treasury Secretary Steven Mnuchin tried to soothe concerns saying that “you can have wage inflation and not necessarily have inflation concerns in general,” suggesting that the administration’s policies would boost productivity.
Skepticism would be understandable given the US administration’s often highly optimistic economic assumptions (e.g. the budget assumes 3% growth over the next decade). But there is evidence to support his claims:
- Headwinds holding back investment spending are dissipating. Business optimism has risen alongside a strong economic growth outlook, and the labor market continues to tighten, making the case for substituting capital for labor.
- Trump's policies should help. Tax reform will play a role in unleashing excess cash, part of which is likely to be used for capital expenditure. A less stringent regulatory environment may also help.
- Productivity often improves late in the business cycle when the economy is running near potential. With the US close to full employment, the pace of growth in payroll numbers is likely to slow, while we expect growth to pick up, in part because of fiscal stimulus. Productivity should rise: the consensus forecast for US productivity growth this year is 1.6%, up from 1% in 2017, according to Consensus Economics.
Overall, investment spending and productivity growth may allow higher wage growth, without it feeding through to a significant pick-up in inflation, which would prompt an increased pace of Federal Reserve tightening. We expect four rate hikes in 2018 and three in 2019.
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