Even as global markets churned in the wake of Donald Trump’s stunning election win, the US Federal Reserve appeared to be sticking to its guns on monetary policy on Friday as one of its top officials laid the ground for a second increase in short-term interest rates.
Stanley Fischer, vice-chair of the Federal Reserve Board, said in a speech that the case for gradually removing some more monetary accommodation was “quite strong” although policy was by no means on a preset course.
Mr Fischer also said the Fed would welcome greater fiscal support for the economy amid signs that Mr Trump and the Republican-dominated Congress are preparing for tax cuts and larger budget deficits.
Speculation that the incoming Trump administration will be pushing for a reflationary fiscal stimulus has triggered tumult in global markets, provoking the worst week for global fixed income since the taper tantrum in 2013.
Mr Fischer said in a question-and-answer session that the Fed was monitoring events in financial markets, but Tim Duy, a close Fed watcher at the University of Oregon, said if rising bond yields were reflecting expectations that looser fiscal policy will deliver an improving growth outlook it should leave the Fed on track to lift rates by another quarter point in December.
“They don’t want to be behind the curve,” he said. “They have repeatedly said they want [more fiscal support] and one reason is to get interest rates higher so they could use traditional monetary tools again. They wanted that help from the fiscal side and it looks like they are going to get it.”
Mr Trump’s plans for unfunded personal and business tax cuts would, according to analysis from the Tax Policy Center, lead to a rise in the federal debt by $7.2tn over the first decade. In addition, Mr Trump’s transition team has pledged to invest $550bn in infrastructure.
Congress is unlikely to accede to such a vast deficit blowout but analysts have noted that there is a history of Republican-led administrations loosening fiscal strictures despite conservatives’ notional opposition to Keynesian stimulus efforts. The response to a big budgetary stimulus would be for the central bank to tighten on the monetary side as it ensures inflation stays under wraps.
In a note, Roberto Perli of Cornerstone Macro said: “The US economy has been plagued by low productivity, a low potential growth rate, and a low neutral interest rate ever since the crisis. Cuts in corporate taxes, government investment in infrastructure, and a reduction in the regulatory burden have at least the potential for changing all that and for bringing with them a more normal inflation rate.
“At the same time, the size of the fiscal expansion proposed by Trump during the campaign raises concerns about the size of the debt.”
Even before the Trump win opened up the prospects for a fiscal stimulus, the US economy was on a strengthening path and numerous Fed policymakers were agitating for higher rates amid a jobless rate that stands at just 4.9 per cent. Wage inflation now stands at its quickest pace since 2009, supporting arguments that the US is nearing full employment.
The Fed’s next meeting is on December 13-14. In its last statement the central bank said the case for higher rates had strengthened and that it was now just waiting for “some further evidence” of progress before pushing through a second rate increase following last December’s quarter-point move.
Speaking to a Central Bank of Chile conference via video link, Mr Fischer said: “In my view, the Fed appears reasonably close to achieving both the inflation and employment components of its mandate. Accordingly, the case for removing accommodation gradually is quite strong, keeping in mind that the future is uncertain and that monetary policy is not on a preset course.”
Mr Fischer added that no one could claim to be surprised if and when the Fed lifts rates. “Whoever is very surprised and loses a lot of money will have walked into that with their eyes open,” he said.