Markets are swaying in diametrically opposite directions in alternate days on Trump and Fed chair Janet Yellen's comments. The volatility will only increase when they try to attain their respective goals
New Delhi: With Republican real estate tycoon Donald Trump taking charge as the 45th President of the United States of America on Friday, global markets are bracing for a volatile year.
What's worse, the world will now confront a piquant situation when the US President and the Federal Reserve will be at odds every passing day.
Already, markets have been swaying in diametrically opposite directions in alternate days on Trump and Fed chair Janet Yellen's comments. The volatility will only increase when both Trump and Yellen try to attain their respective goals.
Last weekend, Trump has voiced concerns over a over-valued dollar which he says was "killing" export competitiveness of US firms. The dollar slid on the comments. withina day, the dollar made a U-turn after Yellen's reiterated that interest rates have to be hiked quickly as "waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road - either too much inflation, financial instability, or both."
At the fag end of 2016, US equities surged on Trump's growth outlook. However, Fed's signal for aggressive rate hikes is sure to temper that ambitious growth outlook.
As promised during the election campaign, Trump may try to roll out his protectionist and fiscal expansionary plans to push up US GDP growth to 4 per cent and create 25 million jobs. Trump also promised to cut tax rates from 35 per cent to 15 per cent, which in itself is a big fiscal stimulus.
On the other hand, Fed has outlined plans to hike rates thrice by 25 bps in 2017 and many more times in coming years as it fears a spike in inflation.
After raising policy rates by 25 bps to 0.5-0.75 per cent in December 2016, Yellen has projected the median federal fund rates to rise to 1.4 in 2017, 2.1 per cent in 2018 and 2.9 per cent in 2019. This means the Fed is ready to raise rates by 25 bps thrice annually in three years starting 2017.
The rate-setting Federal Open Market Committee also projected US GDP growth at 2 per cent in coming years while inflation was expected to quicken from 1.5 per cent in 2016 to 1.9 per cent in 2017 and 2 per cent in 2018 and 2019.
Given Trump's ambitious plan and upward trend in global oil prices, the actual inflation rate in US may overshoot the Fed target, which will warrant faster rate hikes. If Fed has its way, the aggressive rate hikes will dampen economic activity and make it difficult for Trump to attain the 4 per cent growth during his 4-year stint.
LIES, DAMN LIES, TRUMPONOMICS
Fed should not be blamed for putting a spike on Trump's growth plans. By default, Trump's fiscal plans have been doubted even when the poll debates were on last year.
Contrary to Trump’s claims, experts have warned that Trumponomics may reduce revenues and pile up government debt. Bête noire Hillary Clinton had termed Trump's plan to have a "trumped up trickle-down" effect and lead to loss of 3.5 million jobs.
During the first debate with Clinton, Trump has said "I will be reducing taxes tremendously from 35 per cent to 15 per cent for companies, small and big businesses."
This ambitious plan, according to Tax Foundation, will reduce federal revenue by $4.4-5.9 trillion over the next decade.
Even after Laffer’s curve comes into play—tax cuts lead to higher compliance, boost economic activity and improve revenue collection—it will still lead to decline in revenue by $2.6-3.9 trillion over 10 years.
The irony, experts say, is the biggest beneficiaries of Trump’s proposed tax cuts will be the uber rich as the top 1 per cent of US earners will see their after-tax income rise by 10-16 per cent.
If Trump’s fiscal policies back-fire, will Fed turn dovish on its monetary stance to rescue the US economy? The Trump-Yellen duet promises an overtone, which the markets may not like.