Economic Forecasts

A Preview of the Fed Under Trump

John Taylor, a former Treasury official in the Bush administration, is a top candidate to replace Fed chair Janet Yellen.

Donald Trump’s surprise victory may radically alter the future path of U.S. monetary policy. Yields on long-term Treasury bonds have jumped by more than one-half percentage point since the election. In addition, the markets are pricing in possibly two or three interest rate hikes by the Federal Reserve in 2017.

Although Trump was an early supporter of Fed chair Janet Yellen (likely because real estate developers love low interest rates), he turned critical in the latter stages of the campaign and adopt-ed the Republican line that the Fed’s low-rate policy had distorted financial markets. Trump suggested that Yellen, a Democrat, had kept rates low to help the campaign of Hillary Clinton.But President Trump will not have to suffer Yellen’s chairmanship for long. Her term ends by February 2018, and vice chairman Stanley Fischer’s term ends about four months later. Plus, two of the seven seats on the Board of Governors are now vacant, ready for Trump’s choices. Those choices are important because all seven Fed board members (along with a rotating group of five regional bank presidents) vote on the Federal Open Market Committee, which dictates the Fed’s interest rate policy (see Why Interest Rates Matter).

I believe that John Taylor, a Stanford professor and former undersecretary of the Treasury in the George W. Bush administration, is a leading candidate to take over the chairmanship from Janet Yellen. Taylor is the author of the so-called Taylor Rule, which specifies how the Fed should set short-term interest rate targets depending on the levels of inflation and unemployment. In recent years, the Taylor Rule has called for higher targets than the Fed has set. Republicans critical of the low-interest-rate policy have introduced legislation that requires the Fed to take the Taylor Rule into account in its policy discussions.

The Fed has fiercely resisted this legislation, maintaining that such congressional intrusion into Fed policymaking undermines the independence of the central bank. I have said that application of the Taylor Rule depends on what the Fed believes is the correct “neutral” rate of interest (the rate at which the Fed is neither stimulating nor restricting the economy). As I’ve noted in past columns, there is clear evidence that this rate has fallen substantially in recent years. That means Fed monetary policy is nowhere near as easy as many Republicans believe. Clearly, if Taylor is nominated as chairman, his rule will become front and center.

A change in plans? But Trump and the Republicans may have to change their tune if they want to go through with the tax cuts and infrastructure expenditures Trump has proposed. A number of economic analysts estimate that the tax cuts and infrastructure programs could add $10 trillion to the national debt in the next 10 years. Not only would that pressure the bond market, but faster economic growth and higher inflation should also boost bond yields. Six months from now, Trump might need a chairman who supports lower rates, not a hawk like John Taylor, who has pushed for higher rate targets.

Whoever Trump chooses for the Fed, the Republicans control both Congress and the presidency for the first time since the George W. Bush administration. Markets now see more expansionary fiscal policy and capital-friendly tax cuts than would have occurred if Clinton had been elected. As a result, sentiment is changing in favor of stocks and away from defensive positions in Treasuries.

Those developments should be very favorable for stock investors. Higher interest rates should be more than offset by higher corporate profits, sending stock prices higher. If Trump’s policies of tax reductions and less regulation go into effect, stocks—not bonds—are the place to be.

Most Popular

Retirement Income Shouldn’t Depend on the Market; It Should Depend on Math
retirement planning

Retirement Income Shouldn’t Depend on the Market; It Should Depend on Math

The math isn’t as tough as you might think. It all starts with dividing your assets into three different buckets.
May 23, 2022
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
Why Are Gas Prices Still Going Up?
spending

Why Are Gas Prices Still Going Up?

The cost of a gallon of gas is heading back toward its March highs. What’s driving the resurgence, and will gas prices go down anytime soon?
May 23, 2022

Recommended

Sometimes Renting Is Better Than Buying
investing

Sometimes Renting Is Better Than Buying

A home is an asset that generally appreciates in value, but it might not be the most optimal way to build wealth from an investment point of view.
May 25, 2022
Is Securities-Based Lending a Good Idea?
investing

Is Securities-Based Lending a Good Idea?

Securities-based lending may be a quick way to lay your hands on some cash, but you should be aware of the potential for risk.
May 25, 2022
Kiplinger's Economic Outlooks
Economic Forecasts

Kiplinger's Economic Outlooks

Regularly updated insights on the economy’s next moves.
May 23, 2022
Buy Value Stocks, Says J.P. Morgan’s David Kelly
Markets

Buy Value Stocks, Says J.P. Morgan’s David Kelly

This investing strategist says to use valuation as your guide for stock investing opportunities in the balance of 2022. Plus, bonds are looking better…
May 23, 2022