Ed. Note: This article first appeared in Politico
Will it Be “Your Fired?” – Janet Yellen is heading into war with President Trump.
The Federal Reserve chair, with one year left in her tenure as the world’s most powerful central banker, is almost certain to announce a hike in interest rates by one-quarter point next Wednesday.
She and her Fed colleagues could boost rates further throughout this year, potentially putting a lid on a stock market rally the president loves to celebrate and taking the punch out of a package of tax cuts and infrastructure spending the White House hopes will juice the economy next year and beyond.
And if the Fed conducts an aggressive campaign of rate increases, economists say it could spur a recession in Trump’s first term that dogs Republicans in the 2018 midterm elections and complicates the president’s potential reelection bid in 2020.
“We know from history that a lot of funky things happen in Fed tightening cycles,” said David Rosenberg, chief economist at investment firm Gluskin Sheff and Associates.
Of the 13 cycles of rate increases since World War II, 10 landed the economy in recession, he noted. The three that didn’t took place in the third year of an expansion — not the eighth year, which the economy is in now.
The potential confrontation between Trump and Yellen stems from their opposing views on the state of the world.
Yellen and other members of the Fed increasingly see the U.S. economy as operating near its peak potential with unemployment as low as it can go without sparking inflation and the stock market flirting with irrational exuberance.
In a speech last week, Yellen delivered a remarkably stern warning on the path of rate hikes this year while wrapping it in typically wonkish Fed language: “In the absence of new developments that might materially worsen the economic outlook, the process of scaling back accommodation likely will not be as slow as it was in 2015 and 2016,” she said while essentially promising a rate hike next week barring some kind of catastrophe such as a shockingly weak jobs report on Friday.
Yellen has repeatedly hinted that fiscal stimulus coming out of the White House and Congress could push the Fed to respond with more aggressive hikes.
Trump’s view of the economy is pretty much the exact opposite.
During the campaign he described the US as painfully stagnant and argued the “real” unemployment rate is as high as 42%.
In his inaugural address, President Trump described a landscape of “American carnage” dotted with shuttered factories and filled with discouraged workers.
He promised giant tax cuts, revamped trade deals and stimulus spending to boost growth from its current 2% rate to 4% or better and spark a wave of manufacturing hiring.
That will be hard to deliver under any circumstances, but particularly if the Fed is pumping the brakes by pushing up rates that will make it more expensive for companies and individuals to spend and invest.
“It’s much less fiscal stimulus and much more response to the Fed that drives economic cycles,” said Rosenberg.
“Ronald Reagan came in in 1980 and cut taxes but that did not prevent recession. When the recovery started in 1982 it’s because [Fed Chair Paul] Volcker cut rates dramatically.”
All of this means Trump, and his famously itchy Twitter finger, could start putting the blame on the central bank if faster growth doesn’t materialize.
Trump has already taken repeated aim at Yellen, ripping her for not raising rates faster under Obama and suggesting he will replace her when her term is up in 2018. Presidents generally avoid direct confrontations with Fed chairs.
But Trump has largely dispensed with many other traditional restraints on presidential commentary.
Last September, Trump said Yellen “should be ashamed of herself,” adding that “they want to keep the market up so Obama goes out and lets the new guy raise interest rates — or her raise interest rates — and watch what happens to the stock market.”
If the stock market and economy reacted badly to Fed hikes, Trump could go on the offensive once again, analysts suggest.
“It’s impossible to predict what Trump could tweet about this,” said David Smick, a Washington-based economic strategist. “I can’t imagine the economic and finance-types in the Trump administration would go to public war with Janet Yellen. But you never know with Trump. He might do exactly that.”
And Trump would not be entirely unjustified in complaining about the timing of the Fed’s rate increases.
The central bank planned to gradually boost rates in each of the past two years but held off, hiking just once each year after getting spooked by low oil prices and unrest in Europe and other global markets.
Now the central bank is in something of a bind, with inflation returning to the Fed’s target of 2% and stocks racing ahead on hopes for big tax cuts.
The fear among even those Fed board members most averse to interest rate hikes, such as Lael Brainard, is that if the central bank doesn’t push rates fairly quickly back to a more normal range, they could fall behind inflation and be forced into more dramatic — and recession-inducing — increases.
“There’s a strong feeling that the Fed should have raised rates earlier and been in a situation now where they are much closer to neutral policy,” said Smick. “Now the question is whether they are too far behind.”
John Silvia, Wells Fargo’s chief economist, said that might explain why the Fed is acting pre-emptively now.
“Maybe it’s a lesson of the last two years, because remember a couple of times in the last two years — 2015, 2016 — the Fed was sitting there ready to move and then something came up,” Silvia said.
“So maybe they said, ‘Wait a minute, we can’t do this anymore. Opportunity knocks; let’s take it.'”
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