US: The Fed, the Economy and Donald Trump – BMO CM

Sal Guatieri, Senior Economist at BMO Capital Markets, questions that after last week’s data releases and Yellen’s testimony, can there be any doubt that the Fed will lift rates in four weeks?

Key Quotes

“The current Chair is crowing that “the economy is making very good progress toward our goals”. With the current jobless rate (4.9%) a hair above the FOMC’s estimate of the natural rate, and trend inflation edging closer to the 2% target, some would argue that the Fed already has met its goals. The November policy statement said the FOMC would need to see just “some” further evidence of progress to tighten. Barring a disastrous November jobs report, Yellen’s “very good” comment suggests this final hurdle has been cleared, and that a rate increase could occur “relatively soon”.”

“What happens after December? Will the Fed wait another year before taking another baby step on the normalization trail? Prior to the election, the answer was: quite possibly. Post-election, the answer is: probably not. Along with being data dependent, the Fed is now policy dependent. In response to a question about the impact of looming fiscal stimulus, Yellen kept an open mind, saying the Fed would reassess its outlook for the economy, inflation and policy when there is more clarity from Congress on Trump’s policies. But a hawkish feather went up when she warned that heavy-duty fiscal stimulus could risk overheating the economy.”

“Yellen wisely noted that policymakers need to assess the impact of government measures on both the demand and supply sides of the economy. Measures that help lift the participation rate (such as personal tax cuts), productivity (infrastructure spending), and the capital stock (corporate tax cuts, deregulation and a tax holiday on repatriating profits) would help expand the economy’s productive capacity, thus reducing the risk of overheating. This is the Holy Grail of policymaking: the sure way to achieve stronger economic growth and still keep interest rates relatively low. It’s the scenario equity investors seem to be pinning their hopes on. In coming months, they will need to pay close attention not just to the president-elect’s proposals to boost demand, but also to those that support supply and, perhaps more importantly, do not hamper capacity.”

“The Fed’s future path remains highly uncertain, and will depend heavily on the new government’s policies. If said policies support both demand and supply, the Fed might not need to lean heavily against inflation risks.”