During the presidential campaign, Donald Trump made several comments about the Federal Reserve pursuing low interest rates as a political move — one that was supposedly calculated to work against his chances of being elected. Now that Donald Trump has been elected, some traders might therefore assume that the Fed will either experience a leadership change under President Trump or that monetary policy will now shift.
However, it’s easy to forget that the president can’t unilaterally decide to change monetary or fiscal policy on his/her own.
The Fed Chair is nominated by the president from among the Fed governors and is then confirmed by the Senate. To reduce the politicization of that process, the selection of a Fed governor is done during the middle of the presidential cycle. Fed Chair Janet Yellen’s term isn’t over until 2018, and the other Fed governors are appointed for 14 years with staggered terms.
Unless Janet Yellen resigns, it is unlikely that the president can do much about the Fed’s leadership in the near term.
Trump and the Fed
Having said all that, it seems likely to us that regardless of what the Fed and the president want, or whether leadership changes, interest rates will rise in the near term.
The incoming president has made big plans for fiscal spending (government spending on infrastructure, tax cuts and other projects) that may boost the economy. This is an area where Trump and Yellen are in strong agreement. From a practical perspective, it seems unlikely that the president would want to lose someone who could be an influential ally in that fight, which we think makes it more likely that Yellen will finish her term.
However, like Fed appointments, stimulus spending is subject to the approval of Congress. More specifically, spending is approved by the House of Representatives. The House is at odds with President-elect Trump regarding trade agreements and tariffs, over which the president can exercise a lot of direct control.
Congress also wants tax cuts and spending allocated in very different ways from the incoming president.
Despite these differences, we think it is likely that more stimulus is coming, but its make-up is uncertain.
The real issue here is the effect stimulus has on inflation, which, in turn, affects interest rates on the yield curve. Investors have already started pricing in higher interest rates beyond the overnight rate that will likely be adjusted in December.
If inflation accelerates, then the disagreements between President Trump and Chair Yellen will be moot because the Fed must raise rates or they will go up on their own.
President Barack Obama was also a big advocate for fiscal stimulus and launched the American Recovery and Reinvestment Act (ARRA) in 2009. The plan was to spend $700 billion – $800 billion on infrastructure, tax cuts, unemployment benefits and healthcare. The spending goals were mostly achieved with only minor changes to inflation, but that was enabled by the distorted trade relationship with China and falling commodity prices.
Ultimately, we think there are a few safe assumptions to make about the next few quarters.
- Unless Chair Yellen resigns, she will continue to lead the Fed in the short term. That may imply low rates in the short term, but we suspect higher rates aren’t far behind.
- Trade relationships with China and other developing economies will be a little different, which will likely prevent the U.S. from “exporting inflation” like it has in the past.
- Stimulus and tax cuts of some sort will be implemented, which could create growth and will definitely drive inflation.
- If changes under the inbound administration and fiscal spending/tax cuts are enacted in the short term, the Fed will fall in line with the president because inflation will rise and hikes will be necessary under the Fed’s mandate.
In our opinion, inflation and interest rates (two sides of the same coin) are likely to rise under President Trump regardless of who serves as Fed Chair.
Because stocks are inflating assets, this may not be a bad thing for investors, but it comes with risk. The last two rounds of monetary tightening (2013’s taper and December 2015’s hike) were accompanied by significant declines in the market. In both cases, the declines were temporary, but the short-term effects were very large.
Ultimately, we feel that this is a good time to be an option trader, when big moves are likely in the short term.
InvestorPlace advisors John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.
