US: Expansionary fiscal policy in a high-pressure economy - ANZ

US Congress has passed legislation in recent months, which is likely to result in an expansion of fiscal policy at a time when the US economy is growing at an above-trend pace and close to full employment, explains the research team at ANZ.

Key Quotes

“If an economy hasn’t much spare capacity, then there is a limit to how fast the economy can sustainably grow. Any demand-side stimulus that attempts to push growth above potential will tend to spill over into higher inflation.”

“The March FOMC meeting will be critical to see how FOMC officials assess the impact of this fiscal stimulus on growth and inflation. If officials judge that the US economy has limited spare capacity and/or flexibility to accommodate this stimulus, they could respond with a more aggressive normalisation profile (steeper dot plot).”

“The fiscal stimulus is likely to result in higher longer-term rates and has the potential to heighten overall financial market volatility.”

“What we’re watching

• Fed Chair Powell will deliver his first semi-annual monetary policy testimony against a backdrop of solid growth. Will the consensus definition of gradualism have to change given above trend growth, fiscal expansion and rising inflation?  We expect the Fed to hike by 25bps at its 20–21 March meeting.
• Opinion polls point to a hung parliament in Italy as the most likely outcome of the4 March elections. That may not be a bad outcome for financial markets. In Germany, the result of the SPF ballot on whether to form a government with the CDU/CSU is also due 4 March.
• CPI releases for the euro area and Japan are worth close attention, given that US core CPI has surprised to the upside in recent months. Upside inflation surprises tend to stoke financial market volatility.”