Wouldn’t it be wonderful if the president of the United States and the Federal Reserve saw eye to eye? But this is the real world and this is an era where Donald Trump is president. Chances of that happening are slim to non-existent as we’ve witnessed over the past couple of weeks that Trump has been president.
Trump made it clear on the campaign trail that he was no fan of the Federal Reserve. As a republican presidential nominee, Trump attacked the central bank and its chairwoman Janet Yellen, for keeping interest rates low for political reasons. Although the Fed is designed to act independently of the political process, investors fear that a growing rift with the White House could roil the financial markets and potentially cloud the outlook on monetary policy.
At the December, Federal Open Market Committee (FOMC) meeting, policymakers said Trump’s presidential win could cause interest rates to rise in 2017 and 2018, faster than previously expected. That’s because Trump’s pro-growth policies could stoke faster inflation, necessitating a quicker response from the Fed.
“Most of the steepening of the expected policy path occurred following the U.S. election, reportedly in part reflecting investors’ perception that the incoming Congress and Administration would enact significant fiscal stimulus measures,” the minutes of the December meeting showed.
The Fed is of course referring to Trump’s plan to spend up to $1 trillion on infrastructure over the next ten years. The comments also partly reflect the new administration’s plan to slash corporate and personal income taxes.
Although very little is known about Trump’s relationship with Yellen (if there is one at all), the two parties have a delicate balance to strike. On the one hand, Trump has vowed to boost economic growth through a cocktail of policies that include tax cuts, deregulation and fiscal stimulus. On the other hand, Yellen’s mandate is to ensure this process is managed properly. This includes, among other things, managing inflation and inflation expectations.
Currently, the U.S. central bank targets inflation at 2%. Consumer price growth has trended below that level for much of the economic recovery, forcing the Fed to keep monetary policy ultra loose in response.
Trump’s plans as announced are expected to add another $5 trillion to the $19.9 trillion public debt. Although Yellen shares Trump’s views on how the economy should perform, it doesn’t seem likely that she will sit idly by while the new administration’s policies run up inflation. According to analysts, this is where Yellen and her central bank advisory board wield tremendous power – and why Trump shouldn’t pick a fight with the Fed.
How Yellen and Co. respond to the burgeoning debt is subject to great speculation. An extra $5 trillion on the public purse is a lot more difficult to service if interest rates continue to rise. Although Yellen has been extremely dovish on interest rates, she has supported the Fed’s rationale for gradual policy tightening. This included raising interest rates in December for only the second time since the financial crisis, and vowing to continue policy normalization over the next two years.
To his credit, Trump is moving full steam ahead with his campaign promises to stimulate the economy and renegotiate trade. Since coming to power on January 20, the president has issued more than a dozen executive orders. His executive actions have included pulling Washington out of the Trans-Pacific Partnership (TPP), committing to renegotiating the North American Free Trade Agreement (NAFTA) and ordering the review of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Just last Thursday, Trump promised to unveil a “phenomenal” tax plan in the not-too-distant future.
The announcement that tax cuts are coming sent U.S. stocks to new record highs, a clear indication investors were still looking to the Oval Office for inspiration. The S&P 500 Index, Dow Jones Industrial Average and Nasdaq Composite Index are all trading at all-time highs, extending the rally that began on November 8 when Trump was elected.
The Fed, meanwhile, concluded its first policy meeting of the year on February 1 by keeping interest rates at 0.75%. According to the CME Group’s 30-day Fed Fund futures prices (a tool for gauging U.S. interest rate expectations) rates are expected to remain on hold at least until June if not more. Currently, the FedWatch indicator says interest rates will rise to at least 1.25% by the end of 2017.`
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 Harriet Torry (September 26, 2016). “Donald Trump Attacks Federal Reserve, Yellen During Debate.” The Wall Street Journal
 Board of Governors of the Federal Reserve System. Minutes of the December 13-14 Federal Open Market Committee.
 Jeff Cox (December 15, 2016). “The Donald Trump and Janet Yellen relationship just got more interesting.” CNBC.
 Sam Bourgi (February 9, 2017). “Dow Jones (DJIA) Futures Pop ads Trump Pledges “Phenomenal” Tax Plan. Economic Calendar.
 CME Group. FedWatch Tool.