Donald Trump wants fewer and later. Jay Powell, chairman of the Fed, more and sooner. He is confident that his plan is what the booming economy needs: raise the Fed’s benchmark interest rate from its current range of 2 percent to 2.25 percent by a quarter of a point in December, and by similar amounts three times during 2019. Those increases would bring the Fed Funds rate to about 3.00 percent, which the Fed considers the neutral rate that would keep the economy growing at a non-inflationary rate.
Trump, whose idea of not interfering with the Fed’s decision consists of not calling Powell directly, told the press, “The Fed is doing what they think is necessary but I don’t like what they are doing because we have inflation really in check.” When share prices tanked, he added, “The Fed has gone crazy. . . . Loco.”
So far, the president has confined himself to such criticisms, while at the same time nominating well-qualified candidates to the Fed board. He is right that inflation is under control at the moment, running at about or a bit above the 2.00 percent rate the Fed considers optimal—not so low as to launch an inflationary spiral, not so high as to act as a damper on growth. But Powell’s job is to look beyond today, and take away the proverbial punch bowl—low rates—before the party gets raucous. He believes the economy cannot sustain Trump’s preferred growth rate without triggering inflation.
Trump and Powell see interest rates from different vantage points. Where the president stands depends on where he sits. As a heavily-indebted property developer sitting atop Trump Tower, he favored low interest rates. As a candidate eager to deprecate Obama’s legacy—a growing economy—he railed against then-Fed chair Janet Yellen for keeping rates too low, too long, and creating a “big, fat, juicy bubble.” As a president sitting in the Oval Office and eager for re-election, he again stands for growth-inducing low rates. He sees rapid growth as producing lots of jobs and rising paychecks. In short, happy voters. “I’ve never seen a president that wants interest rates to go up,” JPMorgan Chase CEO Jamie Dimon told the press yesterday.
The president is not without the support of some serious economists. Ed Lazear, chairman of the President George W. Bush’s Council of Economic Advisers, now a Stanford professor, reckons that enough slack remains in the labor market to allow the economy to continue to grow at a relatively rapid pace without risking inflation. And Larry Summers, a serial critic of the administration’s economic policy, agrees with the president, “The dangers are probably more on the tightening side than they are of staying easy for too long.”
Fed chairman Powell need not worry about re-election. His economists, whose record in these matters is not impeccable, are telling him that the economy cannot grow at an annual pace more rapid than 1.8 percent without triggering inflation—the labor market is tight; wages, the costs of fuel, and inputs subject to tariffs are rising; house prices are elevated by historical standards; oil prices are on the upswing; and Trump’s tax cuts are throwing gas on the glowing coals. So he is gradually raising rates and disposing of the Bank’s holdings of government bonds and mortgages—tightening monetary policy, in the jargon of the trade.
This is more than an incremental change in interest rates. It is the end of an era of free-to-cheap money that began when monetary policy turned super-loose in response to the post-Lehman financial collapse. That might have been an appropriate response to the crisis, and it surely was fun, at least for asset holders, while it lasted. The feeling of many folks who own shares and houses was captured long ago in a song popularized by Mary Hopkins, “Those were the days my friend, we thought they’d never end, We’d sing and dance forever and a day, We’d live the life we choose . . . and never lose.” End they have.
Which will hit lots of people where it hurts—their purses and wallets. Start with investors. They like low rates, cheap money, rapid growth, and rising profits. Which is one reason why, when interest rates on 10-year Treasury IOUs rose above 3 percent, and the realization dawned that Powell means business and Trump can only grouse from the sidelines, share prices plunged.
The wounded littering the financial battlefields include Turks, Argentines, and other denizens of emerging markets. If you can get a reasonable return on U.S. securities, why leave your money in the riskier bonds of emerging economies? Higher rates in the United States suck capital out of those countries. That drives up the dollar, which emerging-market economies must buy to pay the interest on their dollar-denominated IOUs and the increasingly expensive oil on which their economies heavily rely. The solution for them is to raise interest rates, slowing the growth of their already-sluggish economies.
Add to the list of the unhappy the housing industry. Higher interest rates on mortgages make it more expensive for potential buyers to qualify for loans, and to meet the monthly payments on their mortgages. Rates now are around 4.9 percent, a level not reached since early 2011. Never mind that mortgage rates topped 6 percent before the financial crisis; for millennials a decade ago—when people were tied to their cable providers and Donald Trump was a property developer ranting against high interest rates—is ancient and unstudied history. For them, what matters is that the monthly payments on the average house are about $285 per month higher than when they began thinking about moving off their parents’ couches. Even with a larger pay packet, a millennial reasonably concludes that renting is the more prudent course.
Then there are highly-leveraged companies, for which an increase in the cost of carrying debt can have a significant effect on profitability. And auto manufacturers, who have been forced to withdraw most of the zero-interest rate deals they offered. In five years the average monthly payment on an auto loan has risen from $457 to $525 because of a rise in interest rates on car loans from 4.46 percent to 5.76 percent. That’s an increase of over $800 per year, which doesn’t sound like a lot until you realize that half of Americans would have trouble finding $400 to pay for an emergency.
Worry not. The new, new normal, with inflation around 2 percent, the Fed’s benchmark rate at 3 percent, long-term rates about a point higher, and growth at somewhere around 2.5 percent, might be a sustainable replacement for the artificial era of asset prices inflated by the availability of cheap money.
James Glassman, JP Morgan’s head economist, says rising U.S. bond yields “are a sign of overall economic strength. . . . Investors are simply gaining confidence in the economy’s ability to support normal interest rates.” The firm’s retail analyst, Matt Boss, believes “the consumer is in a great place.” Jobs are plentiful, average wages are rising as many states and Amazon raise the hourly minimum to $15 per hour, consumer confidence is at a record high, and tax refunds should provide tailwinds in 2019. Retailers, UPS, and Fed-Ex are scrambling to find staff, in anticipation of a merry holiday season
If the tax cuts do stimulate investment in productivity-improving equipment, we might end next year with a steadily growing economy not dependent on artificial stimulus from the Fed. If not, and we return to 1 percent growth or dip into recession, Powell will have solidified the Fed’s reputation as a recovery-slayer, giving Trump someone to blame for a slowing economy. And an excuse to launch a campaign to end the Fed’s independence—the goal of populists since the central bank was established over a century ago.