Trump pushes back on Fed rate hikes
The Federal Reserve serves as America’s Central Bank and is the decision-making body for U.S. monetary policy. Its mandate is to promote the health and stability of our financial system. One of its tools in doing so is the management of the benchmark fed funds rate, upon which short-term debt is often based. By adjusting this rate, it seeks to manipulate spending, investment, employment and inflation to promote economic growth.
Since the Great Recession of December 2007 to June 2009, the U.S. economy has gradually strengthened. Over the past two years, that growth has accelerated, along with the Fed’s concern that the robust consumer demand for goods and services will lead to surging inflation.
To keep rising inflation in check, the Fed raises the fed funds interest rate. Higher interest rates act as a deterrent on consumer spending as the higher cost of debt makes it more expensive to purchase goods and services. This gently taps the brakes on economic growth, preventing the economy from overheating.
Since December 2015, the Fed has enacted seven 0.25 percent rate hikes to the fed funds rate. The next hike is expected in September, and odds are high that another hike – the fourth this year – will take place in December. In addition, the Fed has at least three more rate hikes penciled in for next year.
But raising interest rates is not without risk, and the Fed must walk a tightrope of balancing economic growth and inflation. The ideal pace allows for a steadily growing economy that keeps excessive inflation in check through targeted and measured rate hikes. If the Fed raises rates too fast, it risks prematurely stunting economic growth. Too slow, the Fed risks the economy overheating with runaway inflation. Each scenario would force the Fed to take more sudden and drastic measures to correct, greatly impacting the economic welfare of consumers and businesses.
President Trump, joined by a faction on Wall Street and some within the Fed, doesn’t believe the current level of interest rate hikes is warranted. Despite our surging economy and labor market, inflation is at 1.9 percent, below the Fed’s target rate of 2 percent. Thus, they argue, the Fed’s rate hike agenda is overly aggressive and unnecessarily harms consumer spending and economic growth.
So, why then is the Fed raising interest rates absent a clear sign of inflation?
It is becoming increasingly difficult for the Fed to explain away the lack of inflation while imposing its rate hikes, but it comes down to projections. In other words, according to its predictive economic and forecasting models, higher inflation is just around the corner. The Fed believes, at some point, continued strength in the labor market will eventually trigger higher wages. As wages rise, so should consumer demand for goods and services, driving inflation higher.
However, the Fed has been predicting a surge of inflation for years now, yet only recently has inflation remotely approached its 2 percent target rate. Clearly, reality is not matching their predictions. President Trump’s concern is that given the lack of inflationary pressures, the Fed’s current rate hike agenda is excessive. The four projected rate hikes this year and another three to four next year could put a sudden halt to consumer spending, and ultimately, economic growth.
There is little consensus in the Fed on what is causing low inflation or how long it will last. And therein lies the concern for President Trump. His political leverage is America’s economic strength – a strength he also wields against America’s trading partners in his ongoing trade dispute negotiations. Rate hikes pose inherent risks, and that is something he can ill afford to chance.
Mark M. Grywacheski, Investment Advisor
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Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
