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Feb 16, 2017 08:43 AM IST | Source: Moneycontrol.com

COMMENT: As Trump-Yellen wrangle kicks into high gear, brace for impact

President Trump had been very vocal about the Fed Chair aiding the outgoing administration by keeping rates ‘low for longer‘. Since the end of the 2007-09 recession, the Fed has raised rates once in December 2015 and again in December of last year.

COMMENT: As Trump-Yellen wrangle kicks into high gear, brace for impact
Madhuchanda Dey
Moneycontrol Research

In her first testimony to the Congress after Donald Trump became US president, Janet Yellen recently made the case for a rate hike given how the American economy was back on track. However, as word to the wise, she expressed concerns over the US’ ability to shape its future economic policy. "Waiting too long to remove accommodation would be unwise," Yellen warned.

If she was hinting at a possible rate hike, emerging markets everywhere responded to the news with a big yawn. The Indian Rupee opened stable against the dollar on Wednesday.

Trump had been very vocal about the Fed Chair aiding the outgoing administration by keeping rates ‘low for longer’. Since the end of the 2007-09 recession, the Fed has raised rates once in December 2015 and again in December of last year.

The rift appears to have widened as is evident from Yellen’s caution.

Though both President Trump and Janet Yellen have the welfare of America in their best interests, they have different short-term objectives. Trump is trying to promote growth and the Federal Reserve chair is looking to make sure that such growth is managed properly. Congress assigns the Fed two goals: seek maximum employment and maintain stable prices. Yellen has made it clear that the nation isn’t far from attaining these goals.





At the heart of the rift is also Trump’s fiscal plan: rollback in tax rates and increased domestic infrastructure spending to the tune of USD 1 trillion. According to analysts, Trump's plans could add USD 5.3 trillion to the USD 19.9 trillion national debt. Yellen has warned about taking on more federal debt. The feasibility of Trump’s programme is fully dependent on the cost of servicing the debt. In other words, low rates are going to be pivotal to make aggressive fiscal policy work.

Rising rates will not only push up costs of debt and capital but also the value of the US dollar. A strong greenback gives consumers more purchasing power and cuts the prices of imports. However, it also hurts exports and could stand in the way of making “America Great Again”.

Trump wants to double the tepid GDP growth rate to around 4 percent from 1.4 percent now. Yellen’s Fed evidently doesn’t think that is possible. It projects economic growth of 2.1 percent next year, 2.0 percent in 2018 and 1.9 percent in 2019.

Another obstacle in Trump’s hurdle race is the Dodd-Frank law which seeks to impose a tighter regulatory oversight on banks. Trump wants to dismantle much of it while Yellen feels it is important to maintain key provisions.

Finally, the volatility in the dollar could also shape a potential tension between the two. Some economists believe that the border adjustment tax – or levies on imports -- would have the effect of creating a huge rally in the value of the dollar compared with other major currencies, perhaps 20 percent or more.

To what extent can President Trump curb Fed’s independence?

Yellen’s term as chairwoman expires in about a year. Trump could appoint a new leader to the Fed who is more hospitable to his view. There are two governor vacancies available now; so, Trump could quickly influence the direction of the Fed with new appointees.

Emerging markets like India are not mere onlookers any more. The Dollar Index (DXY) is perhaps tracked more closely than our benchmarks as it is a critical determinant of flows. The advance warning from the DXY is loud and clear: brace for more volatility.
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