United States: Demand keeps inflation sticky – TD Securities

TD Securities economists Oscar Munoz and Eli Nir contend that robust domestic demand in the United States, fueled by AI-related capital expenditure and enduring consumer spending, hinders the Federal Reserve's ability to return to its 2% inflation target. Despite a predicted slowdown in consumer spending in the fourth quarter, the economists anticipate that domestic demand will remain strong and inflation will stay above the desired level.

The surge in domestic demand, driven by AI capital expenditure and a robust consumer, has propelled U.S. economic activity during the third quarter. However, this does little to alleviate the Federal Reserve's concerns about inflation. A key factor behind persistent inflation is excess demand in services, as real spending on goods has stabilized, while services have not followed suit.

This remains a significant hurdle for the Fed to overcome. Looking ahead, the analysts project a decline in consumer spending strength in the fourth quarter, with spending expected to decelerate to 1.8% and GDP growth moderating to 2.3% year-over-year in the fourth quarter. As long as financial conditions remain favorable, domestic demand is likely to stay robust, and inflation will remain stubbornly above the target.

This suggests that the Federal Reserve will likely need to tighten monetary policy further in the near term, with the analysts forecasting an additional 50 basis points of tightening between now and Q1 2027.