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16November2017USEconomicPerspectivesNorthAmericaUnitedStatesEconomicsUSEconomicPerspectivesDate16November2017DeutscheBankResearchUSOutlook:AfirmerFedtokeeptheeconomyfromoverheating■As2017drawstowardaclose,theUSeconomyisongoodfootingforcontinuedabove-trendgrowthin2018andbeyond.Privatesectorfundamentalsaremostlysolid,thelabormarkethasmorethanachievedfullemployment,andfinancialconditionsarehighlysupportiveofgrowth.Theprimaryquandaryintheeconomicpictureiswhereisinflation?■WecontinuetoexpectrealGDPgrowthof2.5%for2017(Q4/Q4),inlinewiththeabove-consensusforecastwepresentedaroundmid-year.Akeydevelopmenthasbeenabroadeningofgrowthdriversbeyondconsumerspending,ascapexandtradehavestrengthenedinrecentquarters.Our2018forecastisalsounchangedat2.3%,whileweraisedour2019projectionatenthto2.1%.Weexpectgrowthtoslowsignificantlyin2020.■Withgrowthabovepotentialovertheyearahead,weexpectsignificantfurtherlabormarkettightening.ContrarytotheFOMCmedianandconsensus,whichseeunemploymentlevelingoffatjustabove4%,wehaveitfallingto3.5%byearly2019.Itshouldbegintoriseagainin2020.■Althoughinflationshouldremainlowthroughyear-end,ourmedium-termviewthatcoreinflationshouldnormalizeisintact.SupportingthisconstructiveoutlookarepositivesignalsfromavarietyofleadingindicatorsincludingrealGDPgrowthandimportprices,amongothers.Wealsodiscussafewstructuralforcesthatmayweighoninflation.■OurFedviewisunchanged:weexpectthenextrateincreaseinDecember,followedbythreehikesin2018andfourin2019.ThisexpectationisabovetheFed’sprojections,asabove-targetinflationandanundershootofunemploymentbelowNAIRUforcetheFedtoraiseratesfurtherthanthemedianFOMCprojectionenvisions.FedtighteningshouldbesufficienttobegintomoveunemploymentbacktowardNAIRUby2020.■ThemostnotablerecentFeddevelopmentisanear-wholesaletransitioninleadership.JeromePowell'snominationforChairshouldrepresentagooddegreeofcontinuityformonetarypolicy,thoughconsensusmaybemoredifficulttoforgeifuncertaintylingersaboutinflation.■PotentialpolicychangesinWashingtonrepresentthegreatestuncertaintytothisoutlook.Regulatoryreformhasalreadygivenanimalspiritsandprivatespendingalift.Taxreformisanimportantwildcard,thoughitfacessignificantpoliticalchallenges.Conversely,potentialdisruptionstotradepolicywouldbeanegativedevelopment.PeterHooper,PhDChiefEconomist+1-212-250-7352MatthewLuzzetti,PhDSeniorEconomist+1-212-250-6161BrettRyanSeniorUSEconomist+1-212-250-6294TorstenSlok,PhDChiefEconomist+1-212-250-2155JustinWeidnerEconomist+1-212-469-1679SouravDasguptaResearchAssociateRajsekharBhattacharyyaResearchAssociateDeutscheBankSecuritiesInc.DISCLOSURESANDANALYSTCERTIFICATIONSARELOCATEDINAPPENDIX1.MCI(P)083/04/2017.Distributedon:16/11/201718:21:08GMT0bed7b6cf11c16November2017USEconomicPerspectivesTableOfContentsIntroduction....................................................................................................3Recentdevelopments.....................................................................................3Policydevelopmentsandoutlook...................................................................7GDPoutlook:Economybeginningtofireonallcylinders............................13Supply-sidegrowthsluggish,butpickingup...............................................16Labormarketoutlook:Morefullemploymentovershoottocome................18Inflationoutlook:Upwardtrendresumingnextyear....................................18OutlookforFedpolicy:Substantialnormalizationstilltocome....................20Risks.............................................................................................................22FedWatch....................................................................................................25Page2DeutscheBankSecuritiesInc.16November2017USEconomicPerspectivesIntroductionAs2017drawstowardaclose,theUSeconomyappearstobeonaverygoodfootingforcontinuedabove-trendexpansiongoinginto2018andbeyond.Householdandbusinesssectorfundamentalslooksolidforthemostpart,thelabormarkethasmorethanachievedfullemploymentandcontinuestoimprove,andfinancialconditionsremainhighlysupportiveofgrowth.TheprimaryquandaryfortheUSeconomicpictureisinflation–whydoesitpersistatsuchlowlevelsdespitethedisappearanceofslackintheeconomy?Financialmarketshaveallbutgivenuponprospectsforameaningfulaccelerationofconsumerpricesintheperiodahead,despitethedistinctpossibility(wewouldsaylikelihood)thatthelabormarketwillcontinuetotighten.Inessence,thePhillipscurveisviewedaspasseorevendead.Asaresult,asignificantdisconnecthasopenedbetweentheexpectationsofthemarketandtheexpectationsoftheFedandmainstreameconomistsaboutwhereinflationprospects,theFed,andmarketinterestratesarelikelyheadedintheyearstocome.Howthisdisconnectisresolvedcouldprovetobequiteunsettlingformarketsintheperiodahead.Suchdisconnectshavebeenresolvedmoreviadownwardrevisionstoeconomists'andcentralbankers'inflationforecastsoverrecentyears.However,asthelabormarketcontinuestotighten,thisuneasydynamiccouldshiftwiththemarkethavingtotakemoreofaleadinanupwarddirection.Theprogressionofthisdancecouldbesignificantlyinfluencedbypolicydevelop