Flatter yield curve, Fed Funds rates close to "neutral" likely to slower pace of tightening in 2019: Wells Fargo Economics

GDP growth looks to have roared back after a soft first quarter. A sharp narrowing in the trade deficit and pickup in consumer spending have propelled the estimate of Q2-GDP to 4.7 percent, according to the latest research report from Wells Fargo Economics.

A resilient pace of hiring underlines the current strength of the economy. Employers added another 213,000 jobs in June, which was right in line with the first half of the year and up from an average of 182,000 in 2017.

Solid hiring as well as faster hourly earnings growth pushed the income proxy up to a 6.4 percent annualized rate in the second quarter. The heady pace of labor income alongside accumulating savings from the recent tax changes should keep consumer spending in the second half of the year close to the roughly 3 percent pace of Q2. Escalating trade tensions, however, bring risks to the outlook.

Capital spending is holding up and remains supportive of growth. Yet uncertainty surrounding U.S. and retaliatory tariffs has made pricing and sourcing more challenging, risking future investment and disruptions to already-tight supply chains. With capacity increasingly constrained, input costs are rising.

Consumer price inflation—the target of the Fed—is also moving up, with the core PCE deflator hitting 2.0 percent in May.

"Amid robust domestic demand, no signs of job growth slowing and core inflation back to 2 percent, we expect the FOMC to raise rates two more times before year end. A flatter yield curve, however, and a fed funds rates close to “neutral” should lead to a slower pace of tightening heading into 2019," the report added.