“I think we have time to make assessments about what the net effects of policy changes will be on the economy before we react,” he said.
He also said the potential impacts of Trump’s proposed tariffs would be complicated by the reaction of US trading partners, with the negative effects on growth being countered by the positive impact of an expansive fiscal impact.
The sharemarket, in its initial reaction to the Trump trifecta – control of the White House, House and Senate – was focused on Trump’s plan to extend and increase his 2017 tax cuts for companies and wealthy households, when they would otherwise expire next year, as well as the pervasive deregulation he envisages.
While the tax cuts would ultimately flow through to increased deficits and an estimated $US7.75 trillion ($11.98 trillion) blow-out in US government debt, the mix of tax cuts and deregulation would initially, as was the case in Trump’s previous term, generate increased economic activity and probably be positive for the sharemarket.
Sharemarket investors seemed less concerned about Trump’s tariffs – a baseline tariff of 10 to 20 per cent on all imports and 60 per cent on imports from China – perhaps because they think they are more bluff and negotiating leverage than a realistic prospect.
Even though a multitude of economists has warned that Trump’s economic agenda, particularly his tariffs and his plan to round up and deport millions of undocumented immigrants, would be inflationary, sharemarket investors have been more focused on the initial growth surge than how the Fed might respond to policies that would probably reignite inflation.
Powell’s comments highlight the tensions in the Trump agenda between those policies that would boost the economy and inflation and those that would detract from growth and depress inflation. The Fed is data-driven, so it won’t respond until it better understands what the net effects of that agenda are, although it would be rational for it to be cautious in the meantime.
The fact that there are conflicting elements to the policies Trump has espoused, with differing implications for shares and bonds, could set up a confrontation between Trump and the MAGA loyalists he is piling into key posts within the administration and Wall Street and the Fed.
Sharemarket investors and the Fed want economic growth with relatively low inflation. Bond investors want the same, along with fiscal discipline to moderate the rate of growth in the volume of government debt securities they are being asked to absorb.
If Trump were to implement all the policies he has promised, they would ultimately be very disruptive and inflationary. They would see the stock of US government debt blow out and the pool of low-cost labour shrink even as government revenues were squeezed by the tax cuts.
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Trump loves the sharemarket, which he regards as a barometer of his success. The market, fuelled by his $US1.5 trillion of tax cuts, rose significantly during his last term – as it has under Biden, with a 53 per cent increase so far.
The last time he was in the White House, though, the economy was still recovering from the global financial crisis.
Interest rates were negligible – the Fed was targeting a range of 0.5 to 0.75 per cent for the federal funds rate – inflation was low and the government debt in public hands was less than $US20 trillion ($31 trillion). The S&P 500 index was about 2365 points when he was inaugurated.
Today the economy is growing solidly and the targeted federal funds rate range is 4.5 to 4.75 per cent. Inflation, while subsiding, is at 2.6 per cent, and “core” inflation (excluding volatile food and energy prices) is 3.3 per cent with government debt at $US35.5 trillion and rising. The S&P 500 index is now at 5870. There’s less latitude for misadventures.
US Federal Reserve chairman Jerome Powell hinted there may not be another rate cut this year.Credit: AP
The US can’t afford another bout of debt-funded growth off a reduced revenue base. A rekindled inflation rate would exacerbate the cost of profligacy.
Neither can the sharemarket, which is priced for near-perfection and the soft landing – moderate inflation, falling interest rates and no recession – that the Fed and the Biden administration appear to have orchestrated.
While it would take some time for the full effect of Trump’s policies, if implemented as promised, to flow through, it is likely that Wall Street would revolt – there would be a massive sell-off – if the worst prognostications of economists were realised.
In effect, the sharemarket could be a check on Trump and the extent to which the motley crew he is installing in the administration (generally a more controversial and sycophantic lineup than that of his last term and therefore less of a check on his instincts) can disrupt the US economy and, because of its centrality to global economic conditions, the global economy.
There’s also the bond market – more risk-averse and more inflation-focused than the sharemarket – which could force up market yields and the actual cost of funds for US companies and households regardless of what the Fed does. Indeed, that’s already happening, with the 10-year bond yield rising 17 basis points, to 4.44 per cent, since the election.
MAGA might be ascendant but, between them, the Fed and Wall Street have the firepower to derail Trump’s agenda should they come to believe that it threatens their objectives.
The Fed, of course, could play a major adversarial role and defy the inevitable attempts at intimidation from Trump, who can’t get rid of Powell (as chairman, as opposed to his position as a governor and his place within the Open Market Committee that decides monetary policy) until 2026.
Trump would like to have influence over the Fed’s decisions and would sack Powell if he could, but he knows he can’t, and Powell has made it clear he’s not going anywhere. He’d be underestimating the intelligence and resolve of Powell and the Fed’s board if he thought he could steam-roll them and coerce them into overlooking a resurgence of inflation on their watch.
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MAGA might be ascendant but, between them, the Fed and Wall Street have the firepower to derail Trump’s agenda should they come to believe that it threatens their objectives. It’s going to be an “interesting” four years, and not just for the Fed or investors.
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