Fed Rate Hikes Are Off The Radar For A Reason

Market participants are no longer focusing one-time obsessive game of watching for hints of Fed rate hikes to come. Those central bank bread crumbs left on the trail, which was previously the focus of Wall Street analysis ad nausea, is now, with an FOMC meeting approaching this week, virtually nonexistent. Next Wednesday’s Federal Open Market Committee meeting will likely come and go with not much more than a yawn. There is a reason for this, Capital Economics notes. Fed watchers around the world will engage in a game of wait and see what emerges from the Trump administration in terms of fiscal stimulus, tax cuts and trade wars before any dots can be realistically plotted.

The fog of uncertainty is likely to push the Fed rate hikes in the backseat until June

One thing is clear after the first week of the Trump Administration: nothing is clear. This fog of uncertainty is likely to impact Fed thinking. Wednesday’s FOMC meeting is expected to be a non-event because what Janet Yellen’s surgical crew is looking to do is withdraw the needle of dependency without creating a market shock. As if that task wasn’t difficult enough, now a quick to the draw US President has put in front of the Fed surgical team a layer of fog.

What the fog is obfuscating is what is an increasingly complex formula. There is fiscal stimulus to which Trump has promised, which has been put on hold at least temporarily as the negative impacts of repealing Obamacare – another tail risk in the stimulus withdrawal formula – is currently being addressed in Congress. And tax cuts, the low hanging Congressional fruit that could be easiest to pass.

“The Fed will remain in wait-and-see mode until it has more clarity on the magnitude, composition and timing of the anticipated fiscal stimulus,” Capital Economics Paul Ashworth wrote, speculating the fog will clear in June. It is at this time could Fed bread crumbs might be made great again. If the fiscal stimulus models hot, watch for the Fed to ramp up their surgery on an economic patient generally in some of the best shape of its life.

With Trump action on stimulus, tax cuts and Obamacare, Fed is likely to have an opposite reaction

Stimulus is not a given and may involve a fight with Republican conservatives who insist that significant debt expansion could endanger the economy long term. What is the easy lifting is a major package of tax cuts that might occur by mid-year. If this occurs, Ashworth anticipates 75 basis points of monetary tightening to follow before the year ends. This could bring the fed funds rate to between 1.50% and 1.75% at year-end, assuming Fed asset selling amid a bloated balance sheet doesn’t act as an accelerant to the process.

We cannot stress enough how much uncertainty there is surrounding what the incoming Trump administration will actually do in the first half of this year. Given the agreement between President Donald Trump and the House Republicans, it’s possible that the proposed cuts to personal income tax rates will be passed as a standalone measure fairly rapidly, in which case the Fed might raise interest rates earlier this year. On the other hand, if changes to personal income tax rates are delayed because Trump and Congress can’t agree on reforms to corporate tax and infrastructure spending, then the fiscal stimulus could be postponed until much later this year. If the latter happens and triggers an adverse reaction in financial markets, then the Fed might not raise rates at all this year. In short, the considerable uncertainty over fiscal policy means there is considerable uncertainty over monetary policy too, because the latter will be reacting to the former.

It is not just fiscal stimulus that could result in inflation doctor visits could go up without Obamacare and tax cuts are an inflation wild card — all contributing to Fed rate hikes

While fiscal stimulus and Trump tax cuts are factors, so too is the conventional wisdom on a border tax and tariffs. Both could ignite inflation, which would turn change the calculus on Fed interest rate hikes, raising the ante.

The Fed will also be focused on the potential roll-back of the Affordable Care Act (Obamacare). The move is expected to result in medical care price inflation. In other words, the cost of going to a doctor, without a centralized regulating force – will increase.  Medical price inflation is a key component of the Fed’s PCE inflation measure. Fed watching eyes might be waiting to see the white of inflation’s eyes in this number, which could see lowered drug prices offsetting doctor care costs increasing as offsetting forces.

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Source: valuewalk