Leaning into Trump

The Federal Reserve raised the funds target by 25 basis points to 2 percent today, in line with the universal expectation of market watchers. The FOMC statement  noted strength in consumption and business investment, the continuing decline in unemployment and the gentle upward pressure on core measures of inflation as factors supporting its decision to continue the gradual removal of monetary stimulus.  Two further 25 bp rate hikes are likely by year end.

The Fed is doing exactly what is expected of it in circumstances of full capacity utilization. It isn't taking away the punchbowl just as the party starts to get interesting, but it is trying to ensure that when the party does eventually end, nobody wakes up with too big a hangover.  Contrast that with the behaviour of the Trump administration, which seems to be going out of its way to make the economy overheat. 

The fiscal stimulus provided by this year's budget is exactly what the economy doesn't need when the unemployment rate is as low as it is, at 3.8 percent: additional inflation pressures are the only possible result. Of course, Trump and his economic team profess to believe that the official unemployment rate is way off base, quoting a variety of studies that suggest the actual rate is very much higher. (Here is a relatively moderate example).  Even if this is true to some degree, it is unlikely that the "missing" unemployed will match up well with the job opportunities that may result from the added fiscal stimulus.

Then there are the President's tariff measures, which are certain to add to domestic cost pressures.  Either US companies will choose to pay the tariffs, or because they will opt to switch to domestic suppliers, which will inevitably be more expensive, because if they weren't, the imports wouldn't be arriving in the first place.  If Trump proceeds next to impose tariffs on imported autos, the impact on the cost base and competitiveness of the US car industry would be very severe.

With Trump unlikely to change course on the fiscal front, the Fed is likely to have to keep tightening monetary policy well beyond this year.  How long will it be before Trump, who cannot brook disagreement, starts to take notice?