Federal Reserve: Sideways growth and sticky inflation – TD Securities

TD Securities’ US economists Oscar Munoz and Eli Nir expect US output growth to move sideways in 2026 as the lingering Oil shock and Iran-related risks keep the Federal Reserve on hold through year-end. They see Gross Domestic Product (GDP) growth slightly below trend, unemployment near 4.3%, and core Consumer Price Index (CPI) and core PCE inflation remaining above 2%, with gradual disinflation only resuming in 2027.

Fed seen on extended policy hold

"We expect output growth to move sideways this year, reflecting the lingering impact of the oil shock. The Iran conflict presents stagflationary risks, which we expect will keep the Fed on hold for the entire year. AI and high-income consumers have supported underlying growth."

"GDP growth will likely remain slightly below trend in 2026, ending with 2.1% Q4/Q4. Stable growth should result in a still-low unemployment rate of 4.3% by Q4 2026. The labor market has signaled stabilization, and while we expect that to continue, rising input costs from the oil shock create further uncertainty that could weigh on hiring. We assign 25% odds to a US recession over the next year."

"With supply chains stressed, we do not see substantial disinflation as feasible this year. We expect core CPI inflation to be 2.6% y/y in Q4 2026, ending the year higher than it started. The numbers are similarly high in core PCE terms. Most of the impact of higher oil prices will filter into headline inflation. We look for gradual disinflation to resume in 2027."

"We expect the Fed to remain on hold over our forecast horizon. Inflation should remain high for the rest of the year, and the labor market has stabilized, allowing the FOMC to shift focus to its inflation mandate. If the Fed were to move this year, we believe that move is more likely to be a hike than a cut. Under a new management that espouses a blurrier reaction function, data dependence will gain prominence for determining the path ahead for monetary policy."

"The outlook will be fluid amid uncertainty around developments in Iran and the Trump administration's execution of new trade, fiscal, regulatory, and immigration policies. New developments in financial markets and further escalation of geopolitical conflicts remain key risks for our economic projections over the forecast horizon."

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