Wed, 9 Nov 2016
Even if the Fed holds off in December, the pace of future rate hikes may have to rise due to the inflationary nature of many of Trump's policy proposals.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. One of the things on investors' minds on this day after Trump's victory is what's going to happen to the Federal Reserve and monetary policy. I'm here with Bob Johnson, our director of economic analysis, for his take.
Bob, thanks for joining me.
Bob Johnson: Great to be here today.
Glaser: So, let's start off quickly with looking at the December Fed meeting. Do you think that the uncertainties surrounding what Trump's agenda is going to look like will cause the Fed not to raise rates in December?
Johnson: I think it's going to have a very strong influence on it, and there may be some offsetting factors. But what we've seen in a number of cases overseas where we've had the Brexit vote and a couple of other national elections where we've had issues and dislocations, the central bankers have been there to backstop and they quickly either reduced rates or at least maintained them where they are at, to support the markets so that things don't kind of go into a free-fall. So, to kind of protect markets we've seen this trend where central bankers don't really want to act in the middle of all the uncertainty and all the hoopla here. So, I think, that's certainly another thing that moves strongly against a rate hike in December along with what we've already talked about, kind of a softening economy, and certainly, that may even get a little bit worse here, too, if the softening economy gets a little bit worse because of the uncertainty that we've created.
Glaser: But then how do we think about inflation then? Those price levels have started to move up, and I know it's something that you've been concerned about. Is there going to be even more inflation? Is the Fed kind of behind the ball here?
Johnson: Our view is they've been kind of ahead of the ball. They probably would have been better off acting six or nine months ago when markets were a little bit confident where it may have been able to absorb a rate increase better than it did. But I think now we are probably a little bit behind the eight ball. They may do something here in the short run just to keep things moving along to keep the gears oiled, so to speak, and not try to rock the boat. But after that certainly some of the policies we're seeing potentially out of the Trump administration, and again, we don't know how many will get implemented, but a lot of them have kind of a little bit of an inflationary bet to them which would certainly force their hand a little bit sooner than later.
Glaser: What sort of mechanisms of those policies would create inflation?
Johnson: I think the number one is that he has talked about tax cuts, which having both houses of Congress, I think, some type of tax cut or restructuring is probably quite likely. And he probably wants to do and especially, since he has got a background in building things, that infrastructure building will be part of the equation. And those things, kind of more spending combined with less revenues, is going to tend to push the deficit up which nobody seems to have a real problem with these days which is a little bit scary, but it certainly will push the deficit up. And historically, deficits have helped move up inflation and have generally caused rates to move higher. So, we've had this short-term dislocation situation where the Fed wants to help, but certainly you've got this tax policy and spending policies, if implemented, would likely raise inflation and cause higher interest rates.
Glaser: So, it could be that over the medium term we could see higher rates than maybe we expected only a few months ago?
Johnson: Yeah, and I think, higher inflation, too. And certainly, on the trade side of the house, if we put up some trade barriers there, that makes goods more expensive in the U.S., that's certainly kind of an inflationary thing that the Fed will have to keep in mind. So, there's a number of things that he could do that would scare people. Even if he limits immigration a bit, that may have the side effect of raising wages a little bit more than the Fed would like to see. Obviously, it's what a lot of workers would like to see and may not be at all bad, but it's certainly something that's probably a tad on the inflationary side and may force the Fed into action.
And I think what it's done is it's limited the Fed short term in terms of what they could do in interest rates so as not to upset the apple cart. On the other hand, I think, now we're going to have a more pronounced rise in interest rates that will come faster and in closer increments than the Fed may have hoped for, if indeed his policies get implemented.
Glaser: Well, Bob, I certainly appreciate your take on what the Fed could do this morning.
Johnson: Thank you.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.