AFTER the rest of the world underestimated Donald Trump’s chances, the Federal Reserve now risks crediting the next president with too much power.
Reacting in substantial part to what it anticipates will be stimulative policies by the incoming administration, minutes from the Fed’s December policy meeting, released on Wednesday, pointed to a faster and steeper pace of interest rate hikes.
Trump, it would seem, is capable of what the combined might of the world’s central banks has been unable to do: stoke inflation. A highly-sceptical view is in order, both of his reach and his grasp.
The minutes paint a picture of a more hawkish Fed than Janet Yellen portrayed in her remarks following Dec’s 25 basis-point hike.
“There are a number of warning balloons sent up that go beyond Yellen’s press conference comments. The key shift in (the Fed’s) thinking is that fiscal stimulus changes the meaning of ‘gradual’, changes the definition of easy/tight financial conditions, and changes equilibrium values for rates,” Steven Englander, economist at Citigroup, said in a note to clients.
While the minutes make many nods to the multiple uncertainties in the situation, it’s worth noting that “a couple” of participants expressed concern that the Fed’s signaling of a gradual firming may be taken as a “commitment to only one or two rate hikes per year”.
Several of the discussants said a steepening path of rate hikes might also raise the issue of what the Fed does with the money it gets as bonds in its portfolio mature and are paid back. That mention of balance-sheet management is the first of its kind.
“Many participants judged that the risk of a sizable undershooting of the longer-run normal unemployment rate had increased somewhat and that the Committee might need to raise the federal funds rate more quickly than currently anticipated to limit the degree of undershooting and stem a potential buildup of inflationary pressures,” the minutes said.
The Fed is rolling up its sleeves and preparing to get out in front of an expansion spurred by fiscal policy. A “sizable undershooting” on unemployment, if it happens, would constitute an outright failure by a central bank unless, of course, the rules have changed.
They likely have not, and surely won’t for a president making the kinds of noises about tariffs that Trump is, at least as the Fed is currently constituted.
After the shock of his election it is only natural that people, in the markets and in the Fed, will take Trump’s bombast a bit too seriously. That’s not to say that he won’t try to do what he says but a much higher discount than normal should be applied both to his intentions and his power.
Here is a bit of context, courtesy of David Rosenberg, economist at Gluskin Sheff: the core goods group of the consumer price index will likely turn in its tenth straight month of year-on-year decline when December’s figures come out.
“It will be interesting to see how Trump on his own is going to pull the inflation rabbit out of the hat – how he will do what seven years of large-scale money supply growth from Bernanke and then Yellen could not,” Rosenberg wrote to clients.
“So the markets seem to think that Trump will manage to bully his way to get what he wants, but history tells us that even the most effective presidents don’t get more than 60% of the campaign planks through.”
Getting Congress to go along with corporate tax cuts and stimulus spending which will take debt-to-GDP above 100% is a difficult task. And if we’ve learned anything in this past eight years it is that expanding debt has, above a certain level, diminishing returns on economic growth. Trump can’t change that.
If we discount the likelihood of expansionary fiscal policy then we’re left with the parts of the Trump manifesto which tend to cause inflation but stifle growth: immigration controls and tariffs.
On both scores there may be more Twitter grandstanding, aimed at individual companies and driving the short-term news cycle, than actual policy changes.
And the Fed, of course, faces its own communications challenge. It needs to send a signal that it stands ready to tighten more rapidly, but it will be operating in an environment with more noise than at any time since 2008.
Markets, up until recent days, have been big believers of Trump’s impact: driving interest rates up and discounting higher corporate profits.
Whatever hawkish gestures it feels it must make, the Fed should treat an unprecedented president with unusually high scepticism.
Cheer up, much of it may never happen. – Reuters
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