Federal Reserve Chair Janet Yellen said the primary reason for raising interest rates in March was a simple one: the central bank is confident in a steadily improving economy.
Here’s the rub. The economy hasn’t really been improving lately, it’s actually been deteriorating somewhat. Despite record-setting rallies in stocks and renewed optimism among business leaders, hard data mostly point to a still-subdued environment for both investment and consumer spending.
US economic growth “accelerated July to September only to slow back down in line with trend growth in the final months of the year. More importantly, the slowdown in activity is expected to continue with Q1 GDP poised to be just 1%, according to the latest release of the GDPNow model from the Atlanta Federal Reserve,” said Lindsey Piegza, chief economist at Stifel, Nicolaus & Company.
- Federal Reserve Bank of Atlanta
So while the Fed has promised to raise interest rates a few more times this year – some say two more, others three – the reasoning for such an increase may be unraveling a bit.
“A moderate rise in inflation at the start of the year was more than enough justification for a March rate hike,” said Piegza. “However, going forward, a continued lackluster growth profile will make it increasingly difficult to suggest additional rate hikes are warranted, particularly if energy prices stabilize in the coming months, removing the upward support to headline price measures.”
What about the notion that a fiscal stimulus from the administration of President Donald Trump could boost growth unexpectedly and thereby force the Fed to tighten policy more quickly than expected?
This seems unlikely anytime soon, especially since the failure of Trumpcare appears to have derailed the Republican agenda for the moment, delaying any possible action on the fiscal front probably at least until next year.
“Lacking a super majority in Congress, he will have to resort to the reconciliation process to pass budget (tax cut/reform) legislation,” write Deutsche Bank economists in a research note. “This precludes increases in deficit spending. Infrastructure investment seems destined to be financed by private funds with some but most likely not large-scale public inducement.”
“The window of opportunity for ambitious legislation is thus this year into very early next year,” they add ominously. “After that, passing contentious legislation in an election year will be difficult,” referring to the next round of US congressional elections.
Simon Johnson, MIT professor and former chief economist at the International Monetary Fund, thinks the president’s “next major policy push – on taxes – is in big trouble” after the failure of healthcare.
“The Freedom Caucus and Speaker of the House Paul Ryan primarily want to cut rates for the rich,” writes Johnson in a recent op-ed. “Trump wants a broader tax cut, but one that will increase the deficit dramatically – which the Freedom Caucus will have a hard time swallowing, in part because doing so would expose them to primary challenges.”
What about Trump’s pivot to working with Democrats? Not likely to work, says Johnson. “Why would any Democrat want to assist a president who not only appoints people like Bannon, DeVos, Pruitt, and Perry, but also gives those secretaries free rein to implement damaging and irresponsible policies at home and abroad?”