Hinting at a possible pre-election rate hike when the Federal Reserve Board’s Open Market Committee meets Nov. 1, Cleveland Fed governor Loretta Mester thinks the Oct. 26 GDP report should tell the story. Since the first quarter’s 0.8% GDP number, the second was revised upward from 1.1% to 1.4%, suggesting that Q3 might be enough to convince the FOMC to hike rates Nov. 1.”I would expect the case would remain compelling,” said Mester, one of the Fed governors pushing for a rate hike Sept. 15. Mester and other Fed governors see steady growth through the end of 2016, expecting a better than expected traditional Christmas retail buying season. If October’s Q3 number shows more growth, perhaps at 2% or more, it’s going to undermine GOP nominee real estate mogul Donald Trump’s claim that the U.S. economy has stalled under President Barack Obama.
Trump has proposed cutting corporate tax rates from 35% to 15%, doing the same for small businesses, eliminating the pass-through provisions requiring sole proprietorships or C-corps to file individual and business tax returns. Trump’s tax cuts are designed as fiscal stimulus to go along with the Federal Reserve Board’s rock-bottom-interest rate monetary policy. Trump’s been critical of Fed Chairman Janet Yellen for keeping interest rates at near record lows. If the FOMC reads the economy’s tea leaves as slow but steady growth, then Trump’s stimulus could over do it on inflation, leading to more rapid rate hikes. International Monetary Fund Managing Director Christine Lagarde has asked Yellen to hold off on rate hikes in 2016 citing geopolitical concerns, especially the June 23 Brexit vote, putting more stress on the European Union in the next few years.
Yellen finds herself caught between rock-and-a-hard place, jumping the gun on rate hikes, even if the U.S. economy shows a pulse in the second half of the year. When the economy crashed in 2008 under the weight of the mortgage crisis, former Fed Chairman Alan Greenspan called it another “financial panic,” the same catastrophic event that hits the economy roughly once in a hundred years. Greenspan predicted the recovery from the so-called Great Recession would take at least 10 years. Nearly eight years out in 2016, the economy still looks sluggish, despite what looks like recent improvement in GDP. While Q2 inflation measured at about 1.4%, Mester sees the core inflation rate moving toward the Fed target of 2%. Yellen must decide whether that number looks stable or could deflate quickly, sparking another recession in 2017, as predicted by Chicago-based billionaire investor Sam Zell.
Mester, and other on the FOMC, want a rate hike to offset a possible up-tick inflation, despite recent anemic retail sales growth. Reports Sept. 1 of a slowdown in the U.S. auto industry, or worst yet, a peak in sales, indicates a possible slowdown in 2017. “I don’t think we’re behind the curve,” said Mester, suggesting that the Fed must look ahead to offset inflation. Since 2008, the Fed has worried more about deflation, where too few buyers reduces overall retail prices. “We’ve learned over history that the Fed should be looking ahead and not just waiting,” said Mester, forgetting, that “looking ahead” also means anticipating recession. With Q2 GDP growth of 1.4% it’s hardly indicates that inflation is on the way up. GDP growth could easily drop below it’s current 1.4% if the FOMC reacts to quickly hiking rates before there’s not enough steady economic growth.
Trump’s theory about today’ sluggish growth involves the exodus of good quality manufacturing jobs due to faulty trade agreements, like the North American Free Trade Agreement signed Dec. 8, 1993 into law by former President Bill Clinton. Most economists agree that returning good-paying manufacturing jobs to the U.S. would help U.S. GDP. There’s been a concerted effort over the last 20 years for foreign automakers to manufacture in the United States. Centered in the South, auto manufacturing has benefited the economies of North and South Carolina, Tennessee, Alabama and Georgia. Returning other foreign manufacturers of big-ticket items like flat screen TVs or major appliances would also improve the U.S. economy. If the economy stalls out, working on trade agreements to keep U.S. companies from manufacturing overseas or in Mexico would help the economy.
If Yellen hikes rates before the election, it’s going to signal to voters that there’s no reason to change horses, keeping President Barack Obama’s legacy going. Trump’s made a strong case that the U.S. economy’s sputtering because of incompetent trade deals and fiscal policies. Proposing regulatory reform and draconic tax cuts, Trump’s economic plan calls for an end to the status quo. If U.S. GDP and inflation move upward, it’s going to undermine Trump’s call for major change. If GDP remains flat in Q3, it’s going to keep voters more receptive to Trump’s message. If GDP improves and the Fed hikes rates, it’s going to make a strong case for Democratic nominee former Secretary of State Hillary Rodham Clinton. Trump can talk down about the economy only so long, if the published metrics, like GDP, say otherwise. Unless there’s a compelling reason, voters prefer the status quo.
