By Vincent J. Truglia
I had a pretty clear idea about where US interest rates were going in 2016, which proved quite accurate. I am confident about the direction of rates in 2017, which is up, with the likelihood of as many as four rate rises this year.
The Trump Effect
The number and size of rate increases needed this year relate to the dramatic shift in economic policy caused by the election of Donald Trump (DJT). As you may remember, I voted for DJT, so I was one of those Americans happy about the outcome. However, the fact that the GOP retained control not just of the House of Representatives, as expected, but also keeping the Senate in GOP hands, was an important milestone.
Given that the GOP now controls both the Congress and the Presidency, something not seen since the 1920s, the greater is the likelihood that the DJT/GOP agendas will result in being enacted into law. The question then becomes, how will more conservative members of the GOP deal with DJT’s call for tax cuts, more military spending and more infrastructure spending on a grand scale? Given the powerful and unprecedented use of social media by DJT, I believe Trump will be able to overcome some GOP opposition, getting most of his agenda passed by Congress.
Inflationary Pressure On The Rise
The US economy is fast approaching full capacity. Domestically generated inflation will continue to emerge. Unemployment is already near “full employment.” Wages are finally increasing. Although wage increases are clearly needed, the issue becomes how will domestic prices react, especially in the vital services sector (which is pretty immune to foreign competition) to an economy at or near full capacity?
Timing Of New Laws Will Have An Impact
Much will depend on the speed with which the Trump agenda is enacted into law. From today’s vantage point, it is possible that major changes in fiscal policy might be enacted within the first six months of his presidency. If that is the case, then a pre-emptive interest rate increase of 0.25 percent will likely be needed starting about March. After enactment, the speed of rate increases will depend on the pace of implementation of the new fiscal policies.
If tax cuts occur both for business and individuals within the first six months, then a rate rise specifically aimed at those tax cuts will likely occur. Assuming individual tax cuts are approved, then I expect a 0.25 percent rate rise soon after. Since business tax cuts will take a while before their full impact is felt, this implies further rate increases in 2018 will be necessary.
Higher military spending will have an impact, over time, causing further pressure on rates towards the end of the year, and definitely by 2018.
Higher infrastructure spending could have the biggest impact on rates in 2017. Since infrastructure spending doesn’t usually happen immediately after passage of legislation, assuming that there are already a number of projects which are ready to go, once regulations are cut by DJT, then we could see infrastructure spending impacting 3Q17-4Q17. As such, I expect another two rate increases due to infrastructure spending in the second half of 2017.
Given higher military spending, higher business investment due to the business tax cut and higher infrastructure spending, I anticipate that there will likely be at least four rate increases in 2018, although one or more may be 0.5 percent rate rises, instead of the 0.25 percent increases markets have grown accustomed to seeing.
The election of Trump implies a faster growing economy. However, since any growth will be happening in an economy already at or near full employment and at or near full capacity, a more rapidly growing economy at this point implies more inflationary pressures. In 2017, we are likely to see as many as four rate increases spread throughout the year. In 2018, we are likely to see rates rise by at least another 1.00 percent, with the exact timing difficult to predict so far in advance.
As always, Clear and Candid.