Yellen Will Talk Trump in Thursday's Testimony

  • Fed chair likely to be asked if fiscal policy changes outlook
  • Officials quizzed on Trump policy have said too soon to tell

Less Red Tape Will Boost U.S. Business Confidence: Smead

Federal Reserve Chair Janet Yellen will probably be quizzed about how President-elect Donald Trump’s fiscal policies might affect the economic outlook and path for rate increases when she gives congressional testimony Thursday. Don’t expect a clear answer.

Almost every Fed official who spoke publicly so far this week -- a list that includes nine of the 17 regional bank presidents and Fed governors -- has been asked how tax cuts or fiscal stimulus under Trump could affect the outlook. All have said they’re unsure because it’s not yet obvious which policies will be pursued and enacted. Several have indicated that expansionary fiscal policy could give the Fed more scope to increase rates.

While there’s growing confidence in a rate hike in December, Yellen may not be able to give the bicameral Joint Economic Committee in Washington many additional details on the more distant path for monetary policy. The future is loaded with more than the usual amount of hypotheticals that could alter the central bank’s economic forecasts and rate-hiking speed.

“She’ll continue to beat the drum as far as the Fed’s current outlook goes,” said Sam Bullard, managing director and senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “It’ll be interesting just to hear about the outlook given the political shift in landscape” but “I doubt seriously that they’re going to go too far out in making direct commentary on that until there’s greater clarity.”

Fed Increase

Federal funds futures markets indicate a 94 percent chance that the Fed will increase rates by 25 basis points at its December meeting. On Tuesday, Fed Governor Daniel Tarullo -- who historically has supported maintaining easy policy to help pull workers back into the labor market -- said there’s now a stronger case for talking about hiking to avoid overheating, adding his to the chorus of voices signaling that an increase has become more imminent.

While the December outlook seems fairly set, barring any major economic surprises, what will happen in 2017 is far less certain. The Fed will have to take a look at how fiscal policy changes. 

"We have to take into account what potential changes would happen in policy that would affect our behavior,” Philadelphia Fed President Patrick Harker said in Philadelphia Wednesday. He didn’t speak on Trump’s specific proposals, but said smart tax and other fiscal policies could be important to stimulate growth. “Monetary policy is very limited in what we can do to move an economy forward.”

Trump will assume the American presidency on Jan. 20, after Republicans carried the House and Senate while taking the presidency in last week’s election. The president-elect promised fiscal spending and tax cuts while on the campaign trail, which economists say could boost inflation, potentially spurring the Fed to increase interest rates faster.

On the other hand, Trump’s presidency also raises the possibility of more restrictive trade policies and less immigration, which could weigh on growth over the longer term, economists at Goldman Sachs said in a note.

Pretty Diplomatic

“She’s going to be pretty diplomatic, at this point,” said Scott Brown, chief economist at Raymond James Financial, Inc. in St. Petersburg, Florida.“The Fed doesn’t want to be seen as really interfering.”

Yellen is more likely to talk about the current outlook, which is largely positive: The unemployment rate has held steady near 5 percent this year, wages are increasing, inflation is moving toward the Fed’s goal, and growth rebounded in the third quarter after a slump in the first half of the year. Her prepared remarks will be released at 8 a.m. in Washington, and the hearing starts at 10 a.m.

“She will give a very upbeat treatment of the economic situation,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC, though he said Yellen will walk a fine line to avoid “rocking the boat” ahead of the December meeting. “Markets might be surprised if she got real aggressive and talked about labor-market overheating.”

Another thing to keep an eye out for during Yellen’s congressional appearance: questions about changes inside the Fed under Trump.

The new president will be able to place several officials on the Federal Open Market Committee during his tenure. What’s more, Republicans have floated a number of proposals in recent years that would impact the central bank, including a measure that would force it to follow a rule that would closely tie changes in interest rates to changes in the economy.

Fed Independence

Fed officials have pushed back against such a plan, saying that it would limit their flexibility and could impinge their independence. President Barack Obama said that he would veto legislation that would cause the Fed to follow a mechanical rule, but Trump’s election resurrects the possibility that it could pass.

“She may get asked about that, and I think she would answer the way she has always answered that question,” which is that rules don’t make as much sense as central bank discretion, said Omair Sharif, senior U.S. economist at Societe Generale in New York. “I have a feeling she might get asked more about whether she will resign.”

Yellen’s term ends in 2018, and Trump has indicated that he will likely nominate a Republican to replace her at that point. When Trump economic adviser Judy Shelton was asked whether the Fed chair will serve until the end of her term on Bloomberg Radio last week, she said “I can’t imagine why she wouldn’t.”

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