United States: Sticky inflation underpinned by demand – TD Securities

The Federal Reserve’s 2% inflation objective faces a demand hurdle, argue TD Securities economists Oscar Munoz and Eli Nir. In their view, strong US domestic demand, driven by AI-related capital expenditure and resilient consumer spending, is incompatible with a smooth return to that target. Although they expect consumer momentum to moderate in Q4, they see domestic demand staying robust and inflation holding above target.

Domestic Demand Clouds Fed Outlook

"Booming domestic demand continued to lift US economic activity during the third quarter, with AI capex and a buoying consumer acting as the main growth engines. While this bodes well for the economy's momentum near term, it does not do the Fed any favors regarding the inflation outlook."

"Excess demand in services is a notable culprit. Real spending on goods has normalized, but the same can't be said for services, which is most likely helping to keep supercore inflation uncomfortably elevated. Outside of energy and tariffs, sticky services prices remain a nagging issue for the Fed."

"Looking forward, we expect the US consumer to give back some strength in Q4: the carryover is low (soft Sep), and spending appears to be normalizing in Oct after a hot summer. We are penciling in that spending will cool to 1.8%, with GDP growth slowing back to trend-like speed at 2.3% q/q AR in Q4."

"The upshot is that as long as financial conditions remain broadly supportive, domestic demand will likely stay robust and inflation sticky above target. Put differently, the Fed will likely find itself having more work to do on the policy front. This supports our view that the Fed will have to further tighten the policy screws in the near future: we look for an additional 50 bps worth of tightening between now and Q1 2027."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Learn more.)