Inflation, or its absence, has been one of the key reasons that the US Fed has been able to leave rates at zero even though the US economy grew strongly in 2014.
But all that is about to change, according to Wells Capital Management’s noted US economist Jim Paulsen.
In his latest Economic and Market Perspective Paulsen argues that despite weak growth “overheat pressures are mounting” in the US economy. His key point is this:
With the economy nearing full employment, even remarkably modest growth could aggravate resource pressures, cost-push problems, interest rates, and the speed and magnitude by which the Fed may be forced to calibrate its exit strategy.
Paulsen has put together a cogent argument which highlights the fact that while US growth has been sluggish for years – employment struggling and wages growth low – all that is changing.
Here are his compelling charts which make the argument the Fed must tighten, and sooner than many expect.
The trend in US economic growth is changing
This is happening at a time when employment is nearing full employment and wage costs are rising.
The US economy is nearing full employment
Wages costs are rising
That means that if the US dollar weakness persists it will change thinking “among both policy officials and investors. Already the weakness in the US dollar has helped lift the prices of commodities.”
As Soc Gen highlighted last week, this is also changing the outlook for inflation around the globe.
It all adds up to the increased risk in Paulsen’s view that if these, “pressures continue to intensify, ‘good news becoming bad news’ may increasingly dominate the mindset of both the Fed and the financial markets during the second half of this year.”
That’s a recipe for stock market ructions and a return to strength of the US dollar.
It also means the RBA is likely to be right eventually about a turn in the US economy and the US dollar driving the Aussie dollar down.