By: Jeff Pollock
March 9, 2017
It’s now all but certain that Janet Yellen and her Federal Reserve will jolt interest rates up by another 25 basis points next week when it adjourns their monthly meeting on March 15. Just last week, Yellen herself publicly stated that a rate hike would “likely be appropriate.” As of this morning, the market had priced in with 86% odds the expectation for higher rates. However, the consequences of a rate hike – further US dollar appreciation and a possibly wider trade deficit – could be the nail in the coffin to Yellen’s rein over the Federal Reserve.
Next week will mark only the third rate increase in the past decade. It’s a far cry from a year ago when the world mused about negative rates. At the time, the Bank of Japan foresaw a global “race to the bottom” and Yellen provided congressional testimony that it was a policy option for the Fed to consider.
On the campaign trail last fall, Candidate Trump said that “[Yellen] has always been a low interest rate person and I must be honest. I am a low interest rate person [too]. If we raise interest rates and if the dollar starts getting too strong, we’re going to have some major problems.”
Over the past five years, the US dollar has appreciated considerably against the trade-weighted basket of other currencies. In 2015, the dollar enjoyed its fastest rise in 40 years. However, corporate profits took one on the chin as Q4 operating earnings declined by almost 14% compared to their level one year earlier. This came as no surprise given that almost half of all S&P 500 revenues are generated overseas (mostly in Europe and Asia).
Generally, when a country increases its interest rates, its local currency appreciates too. This is especially true when other countries fail to follow suit. With a more expensive US dollar, the cost of importing American products becomes ever more costly to other countries. This will consequently lead to a higher trade deficit, contrary to Trump’s agenda. Fresh data released on Tuesday showed the US’s January trade deficit at $48.5 billion, a five year high. The larger gap was attributed to a 2.3% gain in imports outweighing the 0.6% growth in exports.
With President Trump targeting trade inequality as a key cornerstone to his policy agenda, a widening trade deficit will surely reach his agenda of “major, fantastic” concerns.
For these reasons, Janet Yellen should beware the ides of March. Her term ends on February 3, 2018, less than a year from today. Monetary policy action that serves to strengthen the US dollar, reduce corporate profits, and extend the country’s trade deficit may result in a career parallel between Janet Yellen and Julius Caesar.
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