Daily Commentary BY THE CURVE TEAM –

Q2 GDP Supports Fed Outlook

30th of July, 2018

Growth in the US economy hit its highest level since 2014 in the second quarter, supporting the Fed’s outlook for the economy and monetary policy normalisation. The stronger outlook for higher rates in the US will have implications for the economy and monetary policy here in Australia.

The US economy grew at an annualised rate of 4.1% in the second quarter. While the outcome fell just short of expectations, it is a solid pick up from the first quarter and will support the Feds outlook and expectations for further rate increases.

One of the most important data points from the GDP report was the fact that nominal GDP rose 7.1% compared to real GDP, which is adjusted for inflation, which was up 4.1%. That means that the GDP deflator was 3%, indicating inflation for the quarter was 3%, above both CPI and the Feds preferred measure, core PCE.

The overall growth figures, including the GDP deflator, will support the path of the Fed with another 2 hikes this year a strong possibility. However, the data will need to remain as there is concern that the looming trade war and government stimulus policy may have pulled forward a lot of demand which could see growth fade a little over the back half of the year.

Ultimately though, rates are still going higher in the US which will have implications for our own economy and setting of monetary policy.

Depending on whether you look at market pricing or the Fed’s dot plot, we could see a further 75-125bp of tightening to the Fed funds rate over by the end of next year. Over the same period, the RBA is expected to remain on hold. This would see the negative spread between the RBA cash rate and the Fed funds rate blow out to its largest deficit on record.

That will have some serious implications for the Australian economy and the Australian dollar. It will not only be up to the RBA but the government to manage the widening differential at a time when the Australian economy looks shaky and the housing market is deteriorating.

David Flanagan

Director - Interest Rate Markets