It was no surprise to learn today that the Fed voted to increase the benchmark US interest rate by 0.25%. The reality is that this was flagged some time ago and there will likely be a further two interest rate rises during 2017. The stock market reacted positively to this move which was brought about by rising inflation and a dip in unemployment figures. So, what does this mean for the short to medium term outlook for the US economy?
Economic growth forecasts
Fed officials expect economic growth in 2017 and 2018 to be around 2.1% before slipping slightly to 1.9% in 2019. This is by no means excessive but with investors looking for a sustained period of growth in the US economy at least the next two years are encouraging. Even in light of today’s interest rate rise these forecasts are still being maintained by the Fed but they are very different to those discussed by Donald Trump.
Can Trump hit 4% economic growth?
You can say what you like about Donald Trump but he is certainly ambitious! We all know that he has promised a massive increase in infrastructure spending, protectionism for the US employment market and a burning of business red tape. In his mind this equates to economic growth of around 4% per annum which is nowhere near that forecast by the Fed. There are therefore concerns that over the next few years there will be friction and conflict between the government and the Federal Reserve at a time when both parties should be working together. Indeed, some people have questioned whether the Federal Reserve should retain its independence.
Short-term outlook
At the moment the clever money seems to suggest there will be a further interest rate rise in June at the earliest. The thinking behind this is that the Fed will need to let today’s interest rate rise filter through the system and see how it impacts inflation and the employment market. Indeed the Fed will also have a very close eye on Donald Trump’s forthcoming policy announcements and his extremely ambitious plans to increase economic growth to 4%. The reality is that 4% is way too high in the current environment and something not seen for many years in the US.
It was interesting to see that the stock market reacted positively to this interest rate rise which suggests that the economy is strengthening and unemployment will continue to fall. The Federal Reserve is keen to maintain very tight control of money market funding as a return to excessive borrowing could hamper a medium-term economic recovery. However, finding a balance between excessive borrowing and starving the economy of investment is not easy.
Conclusion
While this increase in the benchmark US interest rate is fully expected it has highlighted an ever growing chasm between the expectations of the Federal Reserve and those of Donald Trump. The President-elect has talked the talk regarding infrastructure investment and an annual economic growth rate of 4% so now is the time to walk the walk. Talk of reigning in the independence of the Federal Reserve is foolish in the extreme because the Fed has always acted as a buffer between dangerous short-term economic policies and long-term economic growth.