Trump's Economic Agenda Could Get Derailed, Even by Trump

 | Jun 14, 2017 | 1:00 PM EDT
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I received quite a few questions concerning last week's column, "Truth Be Told (and It Seldom Is), Trump Is Getting It Right," so I'm going to expound further on the subject and address how the Federal Reserve makes its decisions on monetary policy. 

The most basic message of that column is that the Trump administration is pursuing policies that are beneficial to the U.S. economy but are being purposefully marginalized, distorted or ignored by the largest media outlets. 

Focusing on or even passively consuming the media narrative concerning the Trump administration distracts investors from being aware of the positive economic events, trajectory and inertia that are happening, and can cause feelings of stress that serve no beneficial purpose. 

It can even serve as the catalyst for some to take actions that are harmful to themselves and others, as evidenced by the attack reportedly targeting Republicans in Virginia today

The continuation of the positive economic trajectory, however, is not assured. There are many things that could derail it and there are many in the federal government, as well as in the media, actively trying to make that happen. 

As well, some of the actions being taken by Trump appear to be counterproductive to his economic agenda. 

By responding to the media and political attacks and attempting to engage his detractors, Trump is allowing them to define the public narrative on their turf, and distracting him from devoting attention to his agenda. 

If that continues, it is possible and increasingly likely that the positive economic trajectory will be halted, and that will also be reflected by investors reversing the current optimistic expectations with negative consequences for equities. 

This situation is more important because the Federal Reserve is actively trying to contain what it perceives to be a growing threat of inflation by raising the cost of debt capital. 

As of this writing, the Fed is expected to raise the fed funds target rate to 100-125 basis points today. That is a double-edged sword economically, which I'll address momentarily. 

Most importantly, though, a rate hike today serves as the definitive measure of how the Fed views its function and what it considers to be "the" economy. 

As I wrote about when the Fed began the process of raising rates, the question left unanswered by the Fed was whether it would stick to a model of economic activity or be more subjective in its approach. 

The answer with a rate hike today is that it has decided to abide by its model. 

That means the Fed is signaling with its actions that the increasing size of the population that is not employable is not its purview. That's an issue for federal, state and municipal governments, along with fiscal policymakers and the private sector. 

The fiscal policy response promised by Trump and Hillary Clinton during the campaign was to pursue infrastructure investments that would create jobs. If Trump fails to focus on that because he's engaging on other political issues, the economy will suffer, investors will not be happy, and his base of supporters will abandon him. 

In the immediate, the steady decline in the 10-year U.S. Treasury yield this year, as the Fed has been increasing the fed funds target rate, is signaling that investors are growing increasingly worried that Trump will not be able to get his economic agenda through Congress. 

Coming back to the double-edged issue of this playing out while the Fed raises rates, the negative side is that the cost of credit card debt and auto loans will increase, providing a drag on economic activity. 

However, on the positive side, the commensurate decline in long-end yields is dragging down mortgage rates into the spring/summer housing season for the first time since the Lehman-crisis era. 

Every year since then, mortgage rates have risen into the spring and summer and quashed expectations of a housing recovery. 

So far this year, that hasn't happened and I don't expect it to now, no matter what happens with fiscal policy, Trump's agenda, the federal budget, debt ceiling and associated matters. 

The primary issue for the bond market, if the Fed raises today, is that the monetary safety net has indeed been removed and will not be returned pre-emptively. 

Fear of the Fed providing that market support has partially been the reason long-end yields have maintained relatively high levels, in keeping with the adage, "Don't fight the Fed." 

With the Fed leaving the "fight," yields and mortgage rates should decline to record lows, in my opinion, as bond buyer confidence rises, and this will be very positive for the housing sector.

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