January 2018 Economic Review

January Economic Update

Will Tax Reform and Full Employment Lead to Inflation in 2018?

In a continuation of recent labor market themes, U.S. nonfarm payrolls expanded in December although falling short of expectations. The U.S. economy added 148K jobs, well-below consensus of 190K in December, and gains in the prior two months were revised lower by a net 9K. While below forecast, the job gains bring the 2017 total to about two million jobs which is flat to 2016. The pace of job creation has moderated as the economy approaches full employment. The unemployment rate held steady at 4.1%, and the labor force participation rate was unchanged at 62.7%. Wage growth missed expectations with average hourly earnings rising 2.5% versus year-ago levels, after a 2.4% gain in November was downwardly revised. Time will tell if the new tax legislation signed in December will result in larger wage gains.

The November CPI report suggests that core inflation may be stabilizing. Core CPI slowed to a 1.7% annual rate in November from 1.8%. The Fed’s preferred inflation gauge, the core PCE, increased 0.6% to a 1.5% annual rate through October compared to 1.4% the prior month. The Fed continues to believe that inflation will stabilize around their 2.0% target over the medium term and supports the likelihood of three or more rate hikes in 2018 in addition to further withdrawal of quantitative easing. The flattening of the U.S. Treasury yield curve remains a persistent theme as shorter-term rates rise on expectations of further Fed rate hikes and longer-term bonds benefit from global demand for yield and duration. At 0.52% (down from 0.56% last month), the spread between 2- and 10-year Treasury yields is the narrowest in over a decade.

U.S. real GDP growth was revised to an annualized pace of 3.2% from the previously estimated 3.3% in the third quarter. Growth was the fastest in two years and suggests the economy entered the fourth quarter on stronger footing with a possible modest lift from tax reform. Consumer spending remains the primary driver of U.S. growth, but significant business investment was also responsible for continued growth. The GDPNow currently forecasts fourth quarter growth at a 2.7% (versus 2.9% last month) annualized rate.

Treasury Yields
Maturity 1/5/18 12/5/17 Change
3 Month 1.375% 1.289% 0.086%
6 Month 1.576% 1.476% 0.100%
1 Year 1.793% 1.656% 0.136%
2 Year  1.960% 1.818% 0.142%
3 Year  2.060% 1.928% 0.131%
5 Year 2.289% 2.143% 0.146%
10 Year  2.476% 2.351% 0.125%
30 Year  2.811% 2.732% 0.079%
Agency Yields
Maturity 1/5/18 12/5/17 Change
3 Month 1.368% 1.323% 0.045%
6 Month 1.485% 1.407% 0.078%
1 Year 1.643% 1.563% 0.080%
2 Year  2.022% 1.896% 0.126%
3 Year  2.144% 2.018% 0.126%
5 Year  2.348% 2.214% 0.134%
Commercial Paper Yields (A-1/P-1)
Maturity 1/5/18 12/5/17 Change
1 Month 1.520% 1.330% 0.190%
3 Month 1.670% 1.490% 0.180%
6 Month  1.840% 1.640% 0.200%
9 Month 1.970% 1.790% 0.180%
Current Economic Releases
Data Period Value
GDP QoQ Q3 ’17 3.20%
US Unemployment    Dec ’17 4.10%
ISM Manufacturing    Dec ’17 59.70
PPI YoY    Nov ’17 4.30%
CPI YoY   Nov  ’17 2.20%
Fed Funds Target   January 8, 2018 1.25% – 1.50%

Source: Bloomberg
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