The Fed Rate Debate (Mar. 14)

Update 169 — The Fed Rate Debate

Does Political Risk Deserve Any Weight?
 
 

As you probably know, the Federal Reserve announcement tomorrow afternoon is expected to confirm an all-but-promised 0.25 percent interest rate increase.

On what basis is Fed acting in this instance?  What is the role of the economy, the markets, and politics in its rate decision?  What are the underlying assumptions behind a hike and what do they imply?  Are political circumstances properly weighed as an input?

This is what we explore today, below.

Best,

Dana

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The Federal Reserve is set to make a decision on interest rates tomorrow, taking many factors into consideration. The new job report, which boasted a 4.7 percent unemployment rate and an uptick in the labor force participation rate, was a sign of a healthy economy.  A surging stock market with a healthy job report point to signs that there will be a rise in interest rates.

Yellen’s Choice

Federal Reserve Chair Janet Yellen, historically cautious, seems to have been pushed by extraordinary circumstances to make this move, the second rate hike in the past ten years. Per American Prospect:

Yellen has brilliantly bobbed and weaved, in the manner of Fed chairs, suggesting that the Fed would surely raise rates sometime soon, but not quite yet.  But the pressure among other Fed governors and regional Fed bank presidents has reached the point where even Yellen has had to join the inflation-hawk camp, lest she get outvoted on the Fed’s policymaking Open Market Committee—a fate that Fed chairs detest.  

 

But is the rising trend in the market a stable trend, or will it fall in self-correction should the administration fail to produce legislative results and enact its policy agenda?   If the Republicans, who yowled and moaned for the past seven years about the ACA, and Trump cannot successfully pull off a swift and comprehensive ACA repeal or even a viable reform, then how will they be able to come together and follow through on the rest of their agenda?

 

This raises the question: what bets are the Fed making on Trump and the Republicans and their efficacy?

Will Trump’s Program Succeed, Legislatively and Economically?

 

Given that the Fed’s choice to raise rates would indicate that the market growth is not an anomaly prone to instability or the impulse to self-correct, and given that the market growth seems to be directly tied to political confidence in the virility of Trump’s agenda: does this mean that Yellen and the Fed tentatively believe that the Trump administration will be able to achieve their policy goals as presented to the watching world?

 

In recent remarks, Yellen has emphasized the risk of rising prices, she has also remained committed to raising rates at only a “gradual” pace in order to leave loose policy in place a while longer.

 

But given that Speaker Ryan’s American Health Care Act appears to be dead-on-arrival, is the Fed making the mistake of taking its cues from a market that might be overpricing itself based on unfounded political optimism?

The Blue Collar Worker

The market isn’t alone in its optimism:  blue collar workers also continue to be optimistic about the future of the Trump presidency, according to polls.  Although the Trump administration has had little time to make any substantial policy changes, the expectation of a reduction in taxes and regulations and the possibility of vast infrastructure spending have created optimism among employers and blue-collar workers.  President Trump has promised to expand the economy by four percent a year, create 25 million jobs in the next decade, revive manufacturing and reduce the trade deficit.

Achieving all that would be difficult in the best of circumstances, let alone with the potential headwinds facing the White House.  Dissension among Republicans and the unpredictability of Trump’s course in several policy areas could dampen job growth.

Current Economic State of the Union

Beyond the financial markets, Yellen’s decision will be informed by a labor force that is experiencing wage growth for the first time in decades. Unemployment is down to 4.7 percent and labor participation ticked up to 63 percent last month.  Median household incomes and average wages are on the rise as well. The labor force is a sign of a somewhat healthy economy and serves as an example Yellen might use as to why the economy is ripe for increasing interest rates.

Given her proposed gradual increase of interest rates, Yellen might be assuming that the economy will be robust under the Trump administration, fueled by spending and tax cuts with no major changes in employment numbers.  If you think the economy is on a healthy trajectory, Yellen’s interest rate hike will not surprise.

Political Risk

But given the uncertainty clouding the Trump administration on every issue, especially the economy, that analysis may be discounting a risk that looks more likely by the day.  It’s the political risk that the program won’t get enacted.  Or that if it does, it might fail in practice.  That the result might be American buyer’s remorse to a degree that ultimately triggers a reversal of fortune and a broad sell off in the markets, constraining, not fueling growth — not circumstances calling out for a rate hike.

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