The US Economy Is Stronger—What Does It Mean for Interest Rates?

US economic activity is picking up, and as a result, we’ve raised our growth forecasts for 2017 and 2018. What’s behind the good news—and how will it impact interest rates?

HURRICANE REBUILDING AND EASY FINANCIAL CONDITIONS

Heading into the last quarter of 2017, two key factors seem poised to boost US economic growth in the quarters ahead.

First, the country will begin to recover and rebuild from this year’s devastating hurricanes in Texas, Florida and Puerto Rico. While the impact of the storms is likely to hold back third-quarter growth, the boost from rebuilding in the fourth quarter and early 2018 should more than make up the difference.

The second growth driver should last longer: financial conditions have been persistently easier than we’d expected. The US Federal Reserve has hiked short-term interest rates three times since last December, but markets and the economy have shrugged it off. Ten-year Treasury bond yields have dropped by 20 basis points, credit spreads are generally lower, the US dollar is about 8% weaker and the equity market has surged to record highs.

OUR GDP FORECAST GETS A MODEST BOOST

We can see the result of all those influences in the economy’s recent performance. And forward-looking indicators—such as the Purchasing Managers’ Index, a gauge of manufacturing strength (Display)—suggest that growth is above potential. We expect this to continue as long as financial conditions remain accommodative.

Our updated forecasts call for a few quarters of above-trend growth followed by a gradual slowing to trend-like growth in the second half of 2018 as less-accommodative monetary policy begins to catch up to the economy. This should keep things from overheating.