Summary: Trump’s unexpected election forced changes in the forecasts and plans of the Fed’s leaders. Today’s decision to raise rates is their first result. Janet Yellen was quite candid about this. The implications of the rate rise are complex. The effects might prove calamitous.
Janet Yellen’s remarks at the press conference
She clearly pointed to Trump’s plans for a combination of tax cuts plus large increases in infrastructure and military spending. The Fed’s leaders have obviously been thinking about the effects of the resulting massive deficits — and decided to preemptively strike against them.
“…We’re operating under a cloud of uncertainty at the moment, and we have to wait and see what changes occur and factor those into our decision-making as we gain more clarity,”
“…Changes in fiscal policy or other economic policies could potentially affect the economic outlook. Of course it is far too early to know how these policies will unfold. Moreover, changes in fiscal policy are only one of the many factors that can influence the outlook in the appropriate course of monetary policy.”
“…There may be some additional slack in labor markets, but I would judge that the degree of slack has diminished. So I would say at this point that fiscal policy is not obviously needed to provide stimulus to help us get back to full employment. But nevertheless let me be careful that I am not trying to provide advice to the new administration or to Congress as to what is the appropriate stance for policy. There are many considerations that Congress needs to take account of and many bases for justifying changing fiscal policy.”
“…Our decision to raise rates should certainly be understood as a reflection of the confidence we have in the progress the economy has made and our judgment that that progress will continue. …It is a vote of confidence in the economy.”
“…We want to feel that if the economy were to suffer an adverse shock that we have some scope through traditional means of interest rate cuts to be able to respond to that.”
— From Reuters. Also see Yellen’s opening statement at the press conference.
Investors raised rates before the Fed acted
Investors immediately raised interest rates after the election. See Freddie Mac’s graph of 30 year mortgage rates (as of December 15). Click to enlarge.
Why is the Fed so eager to raise rates?
We can only guess at the various reasons, and the weight of each in the calculations of the Fed’s governors. They want to build a rate cushion, so they can cut rates in response to the next recession (that’s not so smart if their rate increases help cause the recession). Some of the governors are inflationistas, who always see inflation under their beds. The Fed has traditionally been the big banks’ servant, and they want higher rates to boost their profit margins.
One reason we can rule out: evidence of an acceleration in economic growth. The forecasts of the Fed staff predict a continuation of the 2% GDP growth of 2011-2015: 1.9% in 2016, 2.1% in 2017, 2.0% in 2018, and 1.9% in 2019. That is logical since almost every indicator of economic activity remains stagnant, except for those that are slowing.
Effects of the rate increase
Paul Krugman, as usual says it well.
“So the Fed has raised rates. It was, I’d argue, a mistake, although not as severe a mistake as it would have been a year ago. Anyway, it seems like a good time to review where I think the economy stands, and what it means for monetary and fiscal policy.
“At this point, the evidence does suggest that we’re close to full employment. It’s not so much the headline unemployment rate, which is questionable given low labor force participation. But wage growth has accelerated {no; see below}, and the quit rate is back more or less to pre-crisis levels, suggesting that workers feel pretty good about job prospects.
“…But what if we are about to get significant fiscal stimulus from Trump? Well, it won’t be well-targeted, in terms of either demand or supply; that infrastructure build looks ever less likely, so we’re talking high-end tax cuts with low multipliers and little supply-side payoff. Such a policy might vindicate the Fed’s rate hike, but it should still wait and see.
“Meanwhile, Trump deficits won’t actually do much to boost growth, because rates will rise and there will be lots of crowding out. Also a strong dollar and bigger trade deficit, like Reagan’s morning after Morning in America.”
Update: About those rising earnings, see today’s BLS report. As of November, real average weekly earnings in the private sector have risen 0.5% YoY. That’s a large drop from their 1.7% YoY growth in November 2015. Growth is slowing, not accelerating: up in only two of the past eight months.
Krugman assumes that Congress will approve Trump’s plan. I suspect that is unlikely.
Effects on the economy
The US and global economies have proven themselves astonishingly resilient to shocks since the 2008 crash, although hooked on repeated bouts of fiscal and monetary stimulus. Trump’s victory has sent stocks soaring and bonds falling (long rates rising) on expectation of massive fiscal stimulus — and faster economic growth. Now the Fed has joined the party, boosting short rates.
The likely results are slowing growth from higher rates and a stronger dollar. Further rate increases will prove even more destabilizing, but the prospect of skyrocketing deficits and a overheating economy might push the Fed to do so anyway.
Higher rates + a stronger dollar. What’s the worst that could happen? pic.twitter.com/wJb9asqIzd
— Lance Roberts (@LanceRoberts) December 15, 2016
For More Information
For more information about Trump’s budget based on what we learned during the campaign, see “Promises and Price Tag” by the Committee for a Responsible Federal Budget, 22 September 2016.
If you liked this post, like us on Facebook and follow us on Twitter. See all posts about populism, about our infrastructure, about Trump’s campaign, and especially these…
- The Fed Will Not Raise Rates In The Foreseeable Future, 15 October 2016.
- More Evidence That The Fed Will Not Raise Interest Rates.
- Why New Home Construction Is Slow, And Will Remain So For A Long Time.
- Today’s mythbusting: the Fed is not suppressing interest rates.
- Ignore The Media Chatter, See The 3 Things Investors Should See In Today’s Jobs Report.
- See the warnings about Trump’s infrastructure plan. It’s betraying populism.
- The annual Budget Games begin: Trump vs. Congress to control spending.
