Trump’s shock debt ceiling deal with Democrats could affect Fed policy in unexpected ways

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Donald Trump surprised political observers by caving nearly immediately to Democratic leadership on US debt ceiling negotiations, thoroughly undermining the slick deal-making persona the president tried to play up as a candidate.

Yet the deal has implications for Federal Reserve policy, as noted by Paul Ashworth of Capital Economics in his latest research piece. That’s because the Fed is expected to consider an additional interest rate increase at its December meeting, just as the new three-month-delayed debt ceiling deadline comes due.

“The surprising deal made between President Donald Trump and the Democrats to fund the government until December 8th means that the Fed’s December Federal Open Market Committee meeting could take place against the backdrop of a federal shutdown,” Ashworth wrote.

In addition, “the arrival of Hurricane Irma following Harvey means that the economic data could be affected for the next couple of months,” making it harder for the Fed to get a read on underlying economic conditions.

Great points. Ashworth is mistaken in one area, however: He sees the stopgap debt ceiling measure as a complication that “makes the Fed’s job harder,” as the central bank may now be less likely to hike rates in December.

In reality, it makes things easier. The Fed is already grasping at straws when it looks for justifications for ongoing interest rate increases against a backdrop of stubborn wage stagnation and an inflation rate that has chronically undershot the central bank’s official 2% target.

In other words, there was already very little reason for the central bank to continue raising interest rates until inflation and wages start to move higher. The additional hurdles from the debt ceiling uncertainty should merely seal the deal for a pause.

Ironically, it was Trump himself who had initially staked out an extreme position on the debt ceiling in conflict with his own party, seeking to tie funds for his proposed border wall to its passage and downplaying the potential damage of a government shutdown, even amid major national emergencies like Hurricanes Harvey and Irma.

But in the end, Trump struck the short-run deal with Democrats that left his fellow Republicans stunned, and he has also hinted at a possible agreement, again apart from his own party, to get rid of the debt ceiling altogether.