Fed risks back­lash rein­ing in econ­omy that Congress wants to rev up

Business Standard - - WORLD - CRAIG TOR­RES & LIZ CAPO MCCORMICK BLOOMBERG

The guardian of the punch bowl is at risk of be­com­ing the punch­ing bag.

The Fed­eral Re­serve con­tin­ued to sig­nal at its meet­ing Thurs­day that “fur­ther grad­ual in­creases” in in­ter­est rates are com­ing for the “strong” U.S. econ­omy. It’s a mes­sage that could be in­creas­ingly un­pop­u­lar as Democrats and Repub­li­cans seek more spend­ing next year while gear­ing up for the 2020 fight for con­trol of Congress and the White House.

Democrats soon to be in com­mand of the House of Rep­re­sen­ta­tives are push­ing for in­fra­struc­ture spend­ing and a wider dis­tri­bu­tion of gains to work­ers from a hot job mar­ket. Repub­li­cans want eco­nomic growth to ac­cel­er­ate from their tax cuts, dereg­u­la­tion and de­fense spend­ing. Steadily ris­ing in­ter­est rates can ap­pear con­trary to both goals.

Caught in the mid­dle is Fed Chair­man Jerome Pow­ell, who’s al­ready taking flak from Pres­i­dent Donald Trump for boost­ing bor­row­ing costs while the econ­omy is hum­ming.

Pow­ell, per­haps an­tic­i­pat­ing even more po­lit­i­cal heat, is be­ing proac­tive in his out­reach to Congress, which has over­sight of the cen­tral bank: He has met with or called law­mak­ers 77 times since be­com­ing chair­man in Fe­bru­ary, ac­cord­ing to his cal­en­dar. Dur­ing Septem­ber alone, a busy month that in­cluded a pol­icy meet­ing, his di­ary shows 18 meet­ings or tele­phone con­ver­sa­tions with con­gres­sional mem­bers.

“On the House front, there will def­i­nitely be more crit­i­cism. They will say clearly we have good out­comes, so what’s the hurry?” said Edward AlHus­sainy, a se­nior an­a­lyst for in­ter­est rates and cur­ren­cies with Columbia Thread­nee­dle In­vest­ments. “On the Repub­li­can side, the ques­tion will be, ‘If we roll out more stim­u­lus, are you go­ing to offset it? That doesn’t work for us.”’

The re­al­ity is, both par­ties need to pre­serve the in­vest­ing pub­lic’s trust in the Fed to un­der­write their po­lit­i­cal goals. With­out sound mon­e­tary pol­icy that keeps in­fla­tion in check, nei­ther wage gains nor mod­er­ate bor­row­ing costs on grow­ing fed­eral debt are sustainable.

“Aus­ter­ity is go­ing to be on no­body’s plat­form for the fore­see­able fu­ture,” said Lou Cran­dall, chief econ­o­mist at Wright­son ICAP. Democrats and Repub­li­cans will push the U.S. to­ward “peak fiscal indis­ci­pline” over the next cou­ple of years, he said.

What both par­ties have learned is that, for now, the debt-car­ry­ing ca­pac­ity of the econ­omy ap­pears to be high. One rea­son is the U.S. con­tin­ues to be the world’s big­gest provider of safe as­sets.

“We are the pret­ti­est pig in the pig pen and we will be so for some time,” said David Beck­worth, a se­nior re­search fel­low at the Mer­ca­tus Cen­ter at Ge­orge Ma­son Univer­sity. “We have greater debt ca­pac­ity than we thought we had.”

The pre­mium in­vestors col­lect for the risk of lock­ing their money up in a 10-year Trea­sury note, in­stead of rolling their cash over in short-term ma­tu­ri­ties, is neg­a­tive by one mea­sure, mean­ing in­vestors see lit­tle risk of loan­ing their money to the govern­ment for a decade.

“Trea­sury yields are still his­tor­i­cally low and debt costs are still pretty at­trac­tive,” said Justin War­ing, in­vest­ment strate­gist for the Amer­i­cas at UBS Global Wealth Man­age­ment in an in­ter­view. “If you were go­ing to run a record deficit this is the time to do it.”

Fol­low­ing the pas­sage of the Repub­li­can’s Tax Cut and Jobs Act of 2017 — which rock­eted pro­jec­tions for debt held by the pub­lic to 96.2 per­cent of gross do­mes­tic prod­uct by 2028 from 76.5 per­cent in 2017 — 10-year Trea­sury yields are hov­er­ing around 3.19 per­cent com­pared with 2.4 per­cent at the end of last year.

Over that same pe­riod, longterm in­fla­tion ex­pec­ta­tions, de­rived from Trea­sury In­fla­tion-Pro­tected Se­cu­ri­ties, have barely risen to 2.05 per­cent from 1.98 per­cent. That’s an­other sign of in­vestor faith that cen­tral bank won’t print money to pay the na­tional debt.

The way the Fed keeps in­fla­tion ex­pec­ta­tions nailed down in a hot econ­omy is by sig­nal­ing it is vig­i­lant and will con­tinue to nudge rates higher so long as growth and hir­ing is strong. Fu­tures mar­ket in­vestors are pric­ing in a 75 per­cent prob­a­bil­ity that the Fed hikes a fourth time this year in December. US cen­tral bankers project three more hikes in 2019.

Fed of­fi­cials don’t know how far they have to raise rates to keep sup­ply and de­mand in bal­ance or where “nor­mal” is in the post-cri­sis econ­omy. If fi­nan­cial mar­kets tail­spin, or if ac­tiv­ity cools sud­denly, they will pause and prob­a­bly face some blame. At least one loud voice of Demo­cratic or­tho­doxy is telling them to be care­ful.

Fed of­fi­cials don’t know how far they have to raise rates to keep sup­ply and de­mand in bal­ance

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