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For the first part of the year we would not expect the US economy to head into recession, which has been a fear as of late. We think that right now potential growth in the US is about 1.5%, while our growth outlook for this year is from 2% to 2.5%, which is above trend and should likely come with enough employment growth to push the unemployment rate lower. In fact, we suppose the unemployment rate could fall to about 4.3%, making Q4 average by the end of this year. The question is whether that creates inflation or not.
However, according to the Fed statement, it becomes clear that inflation is moving back towards the 2% target. Nevertheless, we still have some pass-through of the stronger US Dollar into weak tradable goods' prices. I our opinion, we will see some more of that softness through the first half of this year, given the external environment is quite weak, as the Dollar rose quite sharply in recent years. That is why it takes a while for the rise in the Dollar to fully pass through import prices.
Furthermore, we think that core inflation will be more or less stable over the course of the year, obviously above the current level. Though it will dip a little bit lower through the middle of the year, as import prices will remain flat; however, towards the end of the year and then in 2017, we would see the labour market continue to tighten. Moreover, we suppose that domestic inflation should help return inflation to the Fed's 2% target. Still, we see some near-term softness because of a stronger Dollar and the fact that there is still a larger share of tradable inflation. Nevertheless, stronger labour market in the US should support wage growth over time and we will have inflation returning to the Fed's 2% target in terms of PCE inflation by the end of 2017.
For now, the Fed is widely expected to leave rates unchanged at its next meeting in March, while the whole initial path of raising interest rates 4 times this year does not seem to be realistic. Moreover, there recently have been indications that a rate cut could also possibly take place. What is your view? How many hikes/cuts do you see happening this year?
According to our base line forecasts, we would see rate hike happening two times this year: in June and December. We agree that any action in March is highly unlikely. Data has improved and helped stabilize weak market sentiment earlier in the year. Moreover, we have had better-than-expected inflation data, strong labour market data and solid household spending data as well. These factors should keep the Fed in untrack with its bias for higher rates. However, the improvement in the data flow does not really give them enough time to act in the March meeting.
We believe the revised Fed projections will show only a median of thee hikes this year instead of four, which should mean that they skip intended March hike, and focus more on June, September and December. However, there is still a discrepancy between how many hikes we think the Fed will announce this year.
What is your outlook for the performance of the Greenback in the foreseeable future? What else could possibly weigh on the US Dollar this year?
In our macro forecast, we are assuming just 5% appreciation and the trade-weighted value of the Dollar this year. It has come a long way since the middle of 2014; however, I still think that the Dollar is priced in a lot of the potential tightening cycle. Thus, it might be difficult for the Dollar to continue move higher, but, at the same time, we believe the ECB will be easing further just like the Bank of Japan.
Despite oil has stabilized the growth in emerging markets, we would not be surprise to see some modest upward move in the Dollar, though we are not looking for any type of priced moves that we saw in 2014 or 2015.