NEW YORK -At a press briefing held last week at Deutsche Bank Securities' Wall Street headquarters, chief economist Peter Hooper said that U.S. economic growth is expected to be at or above moderate this year, which could trigger inflation to edge higher.
Hooper said that the expected growth trend would be supported by monetary policy stimulus, the declining dollar with a corresponding increase in real net exports, as well as the rise in business investment to pre-recession levels.
Although there are potential drawbacks or risks - consumers' low personal saving rate, vulnerabilities in household balance sheet, elevated oil prices, and the shift to fiscal restraint - these could be easily overstated, said Hooper. Although personal debt levels remain high, Hooper stated that household balance sheets are improving with a lot of the debt funneled to housing assets. Aside from this, loan delinquencies are diminishing and income growth is on the rise.
However, Hooper noted that with the economy returning to full employment and with the dollar receding, inflation is expected to edge higher, with models projecting rising core inflation.
Future Federal Reserve strategy will depend on the labor market performance and core inflation going forward. Hooper said that if the labor market improves and core inflation does not fall toward 1%, the Fed is expected to increase the Federal Funds Rate to over 3% (lower bound of neutral range). Meanwhile if the labor market improves and core inflation rises to near 2%, further interest rate increases to 4% (middle of neutral range) are expected. Hooper said that the Fed - which is expected to move at a measured pace of no more than 25 basis points per meeting - could afford to raise rates gradually and will probably continue to make considerable progress getting the Fed funds rate back into "neutral range" over 2005, although it could overshoot in 2006. He added that the Fed would strive to keep the market fully informed about its strategy.
Hooper also mentioned possible factors contributing to low yields in the bond market: low expectations about growth and inflation, the Fed reducing inflation expectations and inflation risk, heavy Asian buying of Treasury securities, a decrease in corporate issuance, and a huge latent pension fund demand for TIPS and fixed income securities.
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