President-elect Donald Trump promised on the campaign trail to return the US to 4% GDP growth during his presidency.
One of the best ways to achieve this appears to be his proposed $550 billion stimulus package to help rebuild infrastructure.
According to Charles Himmelberg and James Weldon, analysts at Goldman Sachs, Chair Yellen’s comments at the Fed’s December meeting appear to signal a “Yellen Call” that would dampen the financial and economic impact of any large-scale infrastructure plan.
The strategists argue that Yellen is concerned that the economy is near full employment. Thus, adding a large-scale stimulus package that would need a huge pool of labour could drive inflation un-sustainably high.
In order to prevent this, the Fed would increase interest rates, which would dampen some of the flow of credit and in turn business activity, keeping inflation — but also economic and labour market growth — in check. From Himmelberg and Weldon:
“Yellen is clearly focused on the prospects for fiscal stimulus at a time of full employment. When asked about this in her press conference, she noted that ‘… my predecessor and I called for fiscal stimulus when the unemployment rate was substantially higher than it is now.’ And while her comments [on Monday] did not add much beyond last week’s press conference, she nonetheless continued to make the case for ‘the strongest job market in nearly a decade.'”
Now the thinking from Yellen isn’t necessarily to be obstructionist — despite what Trump has suggested about the Chair’s politics — but to sustain the economic cycle.
By adding large stimulus without some sort of monetary offset, inflation could increase too rapidly and the economy would run too hot. So by gradually increasing interest rates to offset the stimulus, Yellen is attempting to run the economic cycle for a longer duration at a lower temperature.
“The growth outlook will soon be capped by the growth rate of potential GDP (if it has not already exceeded it), following which the main consequences of fiscal stimulus are likely to be a combination of higher inflation and higher real rates, with the precise mix to be determined by how hard the Fed decides to lean against the fiscal winds,” wrote Himmelberg and Weldon.
Increasing interest rates wouldn’t totally stifle economic or wage growth, but the pace would be slower than if Yellen allowed Trump’s stimulus to “run it hot.”
According to Himmelberg and Weldon, between Yellen’s comments at the post-Fed meeting press conference on December 14 and her speech at the University of Baltimore on Monday, it appears that this showdown between the Fed and Trump is getting more and more likely.
Additionally, noted the Goldman strategist, some of Trump’s other policies such as “stricter immigration reform and aggressive trade negotiations” could potentially be as much of a drag on GDP as any rate hikes from the Fed.
Trump’s response to this movement by Yellen and the Fed remains to be seen — he hasn’t spoken too highly of the central bank or its chair in the past. Steven Mnuchin and Wilbur Ross, Trump’s picks for Treasury secretary and Commerce secretary, respectively, said Yellen has done a good job at the Fed, so Trump’s more confrontational tendencies may be muted through his cabinet members.
Markets will also be impacted, argued to Himmelberg and Weldon. Equities and other risk assets are having a tremendous run post-election on the prospects on higher growth (and lower taxes), so counteraction by the Fed may dampen their hopes.
“What increasingly seems less uncertain, however, are the risks to risky assets stemming from the ‘Yellen Call’ (the logical successor to the ‘Bernanke Put’),” said the note from Goldman. “This is the idea that subsequent rallies in risky assets from here will likely provoke a more rapid tightening of monetary policy.”
Despite Trump’s claims of a massive economic boost, Yellen and the Fed may put a cap on just how high this stimulus can push markets or the economy.
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