United States: Demand keeps inflation sticky – TD Securities

TD Securities economists Oscar Munoz and Eli Nir argue that strong US domestic demand, led by AI-related capital expenditure and resilient consumer spending, is inconsistent with a smooth return to the Federal Reserve’s 2% inflation objective. They expect consumer strength to ease in Q4, but still see domestic demand as robust and inflation remaining above target.

Domestic demand complicates 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."