- Wall Street’s high hopes for President Donald Trump’s tax plan have been a major driver of the stock market rally, and thus investor confidence.
- The Federal Reserve’s plans to keep raising interest rates in 2018 and 2019 hinge in part on the passage of such a measure, and the short-run fiscal bump it might provide.
- Milton Ezrati, economist at Vested, tells Business Insider the failure of Trump’s tax agenda could prompt the Fed to slow the pace of tightening.
There’s something President Donald Trump could do to make sure the Federal Reserve stops raising interest rates soon, although it might not be in his best political interest to do it – sink his own tax cut plans.
Financial markets have rallied sharply since Trump’s election victory in part because of the prospect of lower corporate taxes, which are the centerpiece of Trump’s plan.
The market rally has been supported by strong investor sentiment and even a pickup in business investment, which, combined with a historically low 4.1% unemployment rate, makes Federal Reserve officials keen to continue raising interest rates even as the inflation rate continues to undershoot the Fed’s 2% goal.
It stands to reason that the legislation’s failure, not an outside possibility given the level of political chaos in Washington and ongoing disagreements within the Republican party, could alter the central bank’s policy path.
“If the market is disappointed on tax reform, and the market has rough patch I think the Fed will probably slow the pace of tightening,” Milton Ezrati, economist at financial services firm Vested, told Business Insider.
Ezrati’s own forecasts for fed funds rate increases are actually on the hawkish side compared to market expectations, which have all but written off additional rate increases in 2018 and 2019 as at best halting, at worst unlikely.
“The market lives with the delusion that the Fed exists for it, and it’s wrong – so I’m with the Fed,” said Ezrati.
The Fed has raised official borrowing costs four times since December 2015 to a range of 1% to 1.25%, and started to gradually shrink its $4.5 trillion balance sheet.
Ezrati sees an additional rate hike next month and further declines in the Fed’s bond holdings over time: “If we can speculate on what [Fed Chair Janet] Yellen is thinking – she’s trying to set it up so that her successor can’t veer too far from her plans.”
Trump announced earlier this month he’s replacing Yellen with Fed Governor Jerome Powell. Most market watchers, including Ezrati, see Powell as likely to extend Yellen’s policy of gradual tightening unless economic conditions shift dramatically.
The absence of a tax cut that has been so long in the making, and political abyss it would signal for the Trump administration, could provide just the right dose of drama, Ezrati said.
“If this bill disappoints – the market has implicitly bet some on it and if Congress fails in one way or another to bring something that is reasonable” investors optimism could quickly sour, he said.
Fed officials “don’t live for the markets but they pay attention to them.” Below are the Fed’s current estimates for federal funds rate increases, known casually among market participants as the “dot plot.”
- Andy Kiersz/Business Insider