This post-election period has been the most interesting in many decades. With Trump not being a politician, we didn’t have as good of an idea of what he would do as president as we usually do at this point in time. A lot of the breaking news reports to come out of the Trump administration are unexpected in the sense that we don’t know what to expect. We now know that Trump will allow Janet Yellen to finish out her term which ends in February 2018. That was the biggest news of the past 2 days.
My viewpoint on what the Fed will do has now changed since Trump has been elected. I have moved to the consensus viewpoint that the Fed will raise rates in December because of the new inflation Trump appears to be bringing with his massive expansion in government spending. Before Trump, the Fed had interest rates low and was able to perpetrate the bubble indefinitely. Now, because the people have had enough of these Fed policies which enrich CEOs through stock based compensation and hurt the working class as the private sector investment rates are declining, the Fed is having its hand forced.
The Federal Reserve is now faced with an impossible task of threading the needle. Donald Trump bringing inflation causes rate hikes to occur. The problem is Trump won’t be able to finance all of this spending on infrastructure through issuing bonds. No investor will want to pay for the bonds unless interest rates increase even more. The higher the interest rates, the less money the government has to spend. The only way for this transaction to take place will be for QE 4 to occur where the Federal Reserve buys the bonds issued for the infrastructure spending.
If this occurs, the jig will be up on the QE program. The Fed has said low interest rates and QE are supposed to help an economy which was in need of emergency measures. The policies were also meant to stabilize asset prices which could create a wealth effect which would stimulate demand in the economy. These policies mainly created asset bubbles, but the point I am making is about their intent. This time it will be obvious that QE 4 will have the intention of funding Trump’s spending. This makes it debt monetization.
Critics of the Fed have said part of the reason for its policies was to keep interest rates on the debt low. They will be vindicated if this plays out next year. The ultimate critic of the Fed, Donald Trump, will need the Fed to help him fund is policies. The only way the Fed will be able to get away with QE 4 without it being viewed as debt monetization is if the economy tanks which obviously isn’t something it wants.
The other question the Fed has to deal with is its flank. The Fed has propped up asset bubbles which have become divorced from economic reality. If the Fed raises rates and long term bonds also continue to rise, the valuations of stocks and real estate will be forced to come down. The only way to maintain the bubbles is if the economy strengthens. This brings us to what has been heralded by the mainstream financial professionals: the handoff from monetary policy to fiscal policy.
The economy needs to live and die on its own merit. Whether the crutch is government spending or easy money policies, the economy being helped out by the government is unsustainable. Government spending crowds out private investment in the near term and leads to a currency crisis in the long term. The question for the market will be if Trump’s fiscal spending can boost GDP growth over more than just one year.
Obama’s economic stimulus ended up being the butt of jokes as shovel ready jobs didn’t materialize. America decided to put a president in office who had more experience with executing massive projects and surrounding himself with competent people. However, the policies are the same. I’m of the belief that the policies were the problem, not the person in office. This was a pivotal point in the GOP primary where Marco Rubio said Obama knew what he was doing and he had bad polices, while Trump claimed he was incompetent.
Looking at the stock market, the stocks which are thought to be helped by Trump such as the industrial firms like Caterpillar should rally until we see what Trump will propose. The market should be headline driven by any new policy which is reported by the media. Since I don’t know what they will be, I don’t know how the market will react. The fundamentals of the economy are weak, so I remain bearish.
Of course, those who rely on keeping you invested will say Trump is a great president for the stock market. They would’ve said that about anyone. My predictions about the next 4 years are predicated on if I have the right information about what will be done. I would never make the blanket statement that stocks will do well under Trump, when I don’t know what he will do and because stocks are overvalued. It’s thought that Trump’s tough trade policies will be a drag on growth, but it depends on the negotiations and what deals are agreed on.
Conclusion
The Fed has a tough situation to deal with. It will have to respond to a weak economy and the big deficits Trump will run up. It also has the uncertainty of who will be in charge in 2018. 2017 will be a transition year between Fed chairs. The Fed may want to raise rates to combat inflation, but it also may need to keep them steady to quell the markets nerves over who will run the Fed next. Does President Trump want interest rates to be high and high government deficits? It seems like an impossible task unless the government re-negotiates the debt. That should bring volatility given how much the uncertainty over the debt ceiling being raised caused the market to fall.