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President Trump is expected to state his nomination for the next Federal Reserve Chair by 3 November, having concluded his interviews this week. The shortlist apparently now stands at five: the incumbent Janet Yellen; Jerome Powell - a governor of the Fed; Kevin Warsh, a former governor; Gary Cohn, who heads the president’s National Economic Council; and John Taylor, a renowned economist at Stanford University.
All are capable candidates, but it is Powell who has emerged as favourite to succeed Yellen in February 2018, with some sources putting his chances at 58%. Under Powell the Fed would most likely maintain a dovish approach to monetary policy, continuing its existing strategy of managing a gradual and orderly increase in rates. This would explain the markets’ sanguine response to his emerging as favourite. Yellen’s criticism of Trump’s desire for financial deregulation has severely damaged her chances of re-election, whilst Powell would likely be open to loosening the existing financial framework. However, a comprehensive overhaul would be highly unlikely under his stewardship.
Still, with Trump in need of a legislative win, he could be tempted at the last minute to nominate a candidate more sympathetic to deregulation. One such figure would be Taylor, whose opposition to excessive government intervention in the markets stands him in good stead. The compromise would be that under Taylor the Fed would most certainly be more hawkish: Taylor’s own ‘Rule’ dictates that the Fed rate should be between 2% and 4% depending upon one’s perception of the natural rate. Even with the natural rate at 0%, which it is not, this would result in a doubling of interest rates in the short term, which could in turn cause a significant correction in asset prices. The risk of such a market correction makes his election unlikely, as it could damage the president’s re-election ambitions; however, with central bankers struggling to generate inflation and real wage growth, it would not be surprising if he were to be offered the post of Vice Chair given his expertise on the subject. With that in mind, the nominations for the other vacant governor positions become even more important to understanding the future path of interest rates.
Trump’s dilemma between low interest rates and promised deregulation was certainly made easier this week as the Senate voted in favour of a 2018 budget resolution. In doing so, they reduced the threshold by which the budget can be passed to a simple majority of 51 senators, thereby negating the need for bipartisan support. As a result Trump should be able to pass his pro-business budget, paving the way for tax reforms that would deliver tax cuts of $1.5trn over 10 years. Despite economists being less optimistic on the impact of such a budget, given that meaningful tax reforms can be notoriously slow and difficult to implement, the markets reacted well, with new life being breathed into the so-called ‘Trump trade’. This was evident with a stronger dollar, surging stocks and rising treasury yields, the latter solidifying the expectation for a December rate increase.
Data released this week in the UK galvanised expectations that the MPC will undertake a 0.25% increase at its next meeting on 2 November, the first such increase in a decade. Both inflation and employment are exceeding the BoE’s expectations, with CPI and the unemployment rate at 3.00% and 4.3% respectively. With limited data releases between now and the next meeting, Wednesday’s GDP figures would have to be extremely disappointing to change policymakers’ minds. This is highly unlikely, however, with Q3 GDP expected to be 0.4% having been 0.3% in Q2 - bringing year-on-year growth to 1.6%.
Despite economic data exceeding the BoE’s own projections, and there being real fears around consumer debt, November’s rate hike is likely to be a one-off for the time being, with further hikes unlikely until next summer at the earliest. Instead, the doves in the MPC will be keen to monitor the impact of its policy change. The inflation report that will be released at the same time will offer a greater insight into the MPC’s thinking, for whatever comfort that may hold; but we will also have one eye on the autumn budget in late November. In spite of promising public sector numbers to come this week, significant giveaways are not expected, although potential movements on the public sector pay cap could still eventually have a significant impact on real wage data. Coupled with real wage growth in the private sector, such a change could add to the calls for a hastening in the pace of the long-overdue normalisation of monetary policy.
Lack of progress in the Brexit negotiations continues to haunt the UK’s economic performance. Further disappointment was evident this week, with Theresa May returning home from an EU summit having failed to break the deadlock. The EU27 remain resolute that insufficient progress has been made to justify negotiations moving forward to include any transitional agreements that companies on both sides are calling for. However, for the optimist there are glimpses of light if one looks hard enough, with the EU27 agreeing to start internal discussions on trade and transitional agreements with the aim of beginning negotiations in December. Perversely it appears that May’s fragilities have spooked the EU, who fear she could be replaced by a Eurosceptic hardliner who would increase the probability of a no-deal scenario. Any optimism should be contained, however, as it is increasingly obvious that to get a seat at this table, whether in December or thereafter, the issue of the divorce bill will need meaningful progress, with Macron claiming that we are less than half-way to where we need to be. Despite being unpalatable and fraught with domestic difficulties, failure to address this issue by 15 December - the next EU council meeting - will seriously restrict the remaining negotiating time to less than 12 months. This very much raises the possibility of an unsatisfactory outcome for the UK. The longer the current stalemate prevails, the more binary our exit looks; with us being left to choose between a ‘no-deal’ agreement based on WTO rules and a long-term transitional agreement resembling that of Norway’s membership of the EEA.
’Separatist’ discourse on the Continent has yet to result in any economic concerns, although the risks are growing. The ECB’s meeting on Thursday should be interesting, as the bank is expected to announce a roadmap to tapering its asset purchasing program from January 2018. Despite the bank’s plans being seen as hawkish, the market’s reaction should be limited given it will most likely come with a commitment to keep rates low.
Tomorrow sees PMI data for the eurozone, which are expected to offer more evidence of a solid recovery. The manufacturing and services sector indices for October are expected to come in at 57.8 and 55.6 respectively – both down a couple of notches from September but still very positive and better than the equivalent figures expected for the US of 53.5 and 55.2, also out on Tuesday. Nonetheless the first estimate of Q3 US GDP growth rounds off the week on Friday and is expected to come in at +2.5% compared to the same period a year ago. This is arguably not the sort of number that begs for fiscal stimulus, but Trump looks increasingly likely to deliver this anyway.
All views expressed here are the Author’s own and are based on information available at the time of writing
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