December 14, 2016

New President May Force Hawkishness on 2017 Fed

by Breakingviews.

Donald Trump may force the Federal Reserve to become more hawkish. The U.S. central bank on Wednesday nudged interest rates up again after a year-long pause. Looking ahead, Chair Janet Yellen and her colleagues have previously sounded cautious. But that was before the Trump bump boosted bond yields, inflation and stock prices.

The Fed finally pulled the trigger at its last meeting of 2016 after steady economic improvement throughout the year, raising the target range for overnight borrowing by a quarter of a point to 0.5-0.75 percent. In the three months to September, U.S. GDP expanded at a 3.2 percent annualized pace, the fastest in two years. The jobless rate in November fell to 4.6 percent, the lowest reading since August 2007.

Fed officials had been guarded about 2017. In September, the central bank scaled back its forecasts for next year from three increases to two amid global economic uncertainty, but brought the projection back to three on Wednesday. Meanwhile the market-implied probability of even two hikes in 2017 was under a third before the Fed’s decision, according to CME’s FedWatch analysis.

Other economic indicators are more optimistic. The 10-year Treasury yield jumped the most in three years the day after Trump’s Nov. 8 election to above 2 percent, and on Tuesday closed around 2.5 percent. The core personal consumption expenditures price index rose 1.7 percent in the year to October, while the headline PCE index rose 1.4 percent. Both are still below the Fed’s 2 percent target but both are the highest in months and should increase further because of rising wages.

Stocks have hit record levels since the election. The S&P 500 Index has gained nearly 5 percent since Trump’s election as the next U.S. president. Investors have been buoyed by his plans to cut personal and corporate taxes and spend up to $1 trillion on infrastructure.

Although the Fed has pushed for fiscal measures to boost growth, Yellen told Congress after the election that the outlook was fuzzy on that front. Fed officials have said their assessment will depend on what proposals are actually approved by Congress.

But Yellen may not have the luxury of waiting and seeing. If inflation and other benchmarks continue to rise, the Fed will soon feel pressure to up the pace of rate increases. Trump, once in office, may not like that idea as much as he did as a candidate.


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