President-elect Donald Trump wants to light a rocket under the U.S. economy. Janet Yellen just started hiding some of the fuel.
The U.S. Federal Reserve on Wednesday raised interest rates for only the second time in a decade with the prospect of as many as three more increases to come in 2017.
Central bank chair Yellen suggested that she and her colleagues would keep their eyes on Trump’s plans for steep tax cuts and infrastructure spending, with the Fed poised to hike faster if the president-elect and the Republican Congress start pumping massive amounts of cash into the economy.
“Some of the participants, but not all of the participants, did incorporate some assumption of a change in fiscal policy into their projections, and that may have been a factor that was one of several that occasioned the shifts,” Yellen said in a press conference after the central bank announced its widely anticipated quarter-point increase.
Yellen deployed the gentlest of gauzy central banker language, cocooning her statement in caveats, but the message was clear. The Fed sees a significant Trump stimulus coming in 2017 and is ready to pump the brakes if necessary. That will likely further unsettle a relationship that already saw the president-elect repeatedly rip the central bank chair on the campaign trail.
On CNBC in September, Trump said Yellen, a Democrat nominated by President Barack Obama, should be “ashamed” of herself for keeping rates low in the final months of Obama’s presidency.
“Any increase at all will be a very, very small increase because they want to keep the market up so Obama goes out and let the new guy raise interest rates and watch what happens in the stock market,” he said.
Now that is exactly what is happening. Rates are going up and they could be a problem for the president-elect.
The emerging Trump-versus-Yellen battle is in large part based on completely opposite views of the current U.S. economy.
The Fed sees unemployment at just 4.6 percent, a third-quarter growth rate of 3 percent and rising wages as signals that the economy is close to overheating.
The central bank wants to bump rates back up to more normal levels over the coming years to prevent crippling inflation. Higher rates encourage savings and make it less attractive for companies to borrow and invest, potentially slowing growth and keeping a lid on a stock market rally that has sent every major average to new highs in the weeks since Trump’s surprise win.
Stocks dropped following the Fed’s announcement and Yellen’s press conference, with the Dow off 150 points, or 0.8 percent, in late afternoon trading.
Trump, by contrast, campaigned on the idea that the U.S. economy is a stagnant mess that is leaving large numbers of workers behind, especially in Midwestern manufacturing states. He has promised to slash taxes, rip up regulations and spend hundreds of billions on infrastructure to deliver a growth rate of 4 percent or better.
“Everything that is broken today can be fixed, and every failure can be turned into a truly great success,” Trump said in an economic speech in September in which he pledged to enact policies that would create 25 million jobs over 10 years.
Rising interest rates, especially if the Fed feels the need to move faster next year to offset the impact of Trump’s big fiscal stimulus, could make those goals even harder to achieve and potentially cut into the president-elect’s already modest approval rating.
“If higher interest rates reflect an economy that is actually improving, then he is probably OK,” said Steven Ricchiuto, chief U.S. economist at Mizuho. “But if you believe that Trump will not really be able to create sustainable, higher economic growth, then the interest rate hikes will be a problem for him and for the economy going forward.”
Trump will not just be fighting the Fed.
Many economists believe that demographic and other broad structural problems in the U.S. economy are holding back worker productivity and limiting the size of the labor force in ways that short-term fiscal policy may not change. Getting to consistent 4 percent economic growth, a level not seen since the 1990s, could prove a very elusive goal for the Trump White House no matter what the Fed does.
“We couldn’t get to sustained 4 percent growth even if we really tried,” said Megan Greene, chief economist at Manulife. “Let’s pretend that Trump does get all of his stimulus. That will help around the edges, but it won’t fundamentally change potential GDP growth in the United States. A massive stimulus probably wouldn’t hit the real economy until 2018 or 2019 and then it would be just a sugar boost that quickly peters out.”
Yellen tried hard in her news conference not to prejudge what the Fed might do in response to Trump’s economic policies.
“I really can’t tell you what the Fed’s response would be to any policy changes that are put into effect, and I wouldn’t want to speculate until I were more certain of the details,” she said.
That may come as some solace to a Trump team that does not want the Fed to step on their efforts to boost the economy. But Yellen also appeared to walk back earlier calls, both from herself and predecessor Ben Bernanke, for fiscal stimulus to aid in economic growth. Her remarks could be seen as a warning to Trump not to go too big on tax cuts and spending.
“I believe my predecessor and I called for fiscal stimulus when the unemployment rate was substantially higher than it is now,” she said. “So I would say at this point that fiscal policy is not obviously needed to provide stimulus to help us get back to full employment.”
But as soon as she said that, Yellen, whose term is up in 2018, quickly tried to back off a bit on telling Trump what to do. “Let me be careful that I am not trying to provide advice to the new administration or to Congress as to what is the appropriate stance of policy.”
Yellen also demurred on whether it was a good idea for Trump to be criticizing the Fed or tweeting criticism of individual companies.
“I’m not going to offer the incoming president advice on how to conduct himself in policy,” she said. “I’m a strong believer in the independence of the Fed.”
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