Academic journal article ABA Banking Journal

Outlook for Growth, Inflation, Rates

Academic journal article ABA Banking Journal

Outlook for Growth, Inflation, Rates

Article excerpt

IN 2004, ECONOMIC GROWTH will remain healthy, staying well above the potential growth rate of 3.5%, lowering the jobless rate to 5.2% at the end of the year. Economic policies will remain a strong tail wind for the economy. During the second half of 2003, Washington provided $61 billion in tax cuts; there is another $149 billion in the pipeline for 2004. The Federal Reserve won't hike the interest rate until late 2004. The central bank wants to see a period of accelerating inflation first.

Almost every major sector of the economy, with the exception of housing and vehicles, should expand in 2004. The improving labor market and the wealth effect from stocks as well as houses should support consumer spending. Businesses have joined consumers in strengthening the economy. Capital spending, especially on high tech, will rise at double-digit rates. Inventories are at rock bottom; production and employment will have to increase to rebuild inventories consistent with rising sales. In addition to the weak dollar, the global economic rebound should be a major plus for exports. Federal spending, both defense and non-defense, will add to economic growth and budget deficits. Even fiscally-strapped states should show modest increases in spending. All told, economic growth (4th qtr./4th qtr.) should be 4.6%, similar to the 2003 pace.

With healthy economic rebound, inflation expectation has begun to rise. When will the Federal Reserve hike the interest rate? Given ample excess capacity, actual price increases outside of energy will remain low for a while. However, the economic rebound and the ballooning budget deficits have heightened inflation expectations. The dollar depreciation will boost import prices and allow import-competing goods to hike prices. Supported by a global economic rebound, especially in China, commodity prices have jumped.

The central bank is waiting for sustained gains in employment, and wants to see a period of accelerating prices before raising the interest rate. The futures market has priced in a higher federal funds rate as early as mid-2004. We believe that the Federal Reserve will start thinking about a higher interest rate sometime late in 2004.

Treasury yields can be divided into two components: inflation expectations and the real interest rate. Since both components are rising, bond yields should rise. Once employment shows meaningful strength, bond yields will go even higher.

Significant gains in employment will be a key catalyst in sustaining the current rally in the stock market. …

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