Where Do We Go From Here?

As expected, the Federal Reserve left interest rates unchanged at last week’s post-Election Day monetary policy meeting, while signaling another 25-basis point increase in the federal funds rate at its December 18-19 get-together.

But the results of last week’s elections, which returned control of the House to the Democrats, may put future rate increases next year in doubt. That bodes well for long-term Treasury bond prices – i.e., yields may have peaked.

As we know, Maxine Waters, D-California, is now the likely next chairman of the House Financial Services Committee. To put it mildly, she doesn’t like banks. Her first order of business, no doubt, is to impeach President Trump, as she’s said countless times. But a more realistic second goal will be to roll back all or most of the recent bank regulatory measures made so far by the Trump Administration, which, of course, rolled back much of the regulatory measures passed under the previous administration, mainly through the Dodd-Frank financial reform law.

If she’s successful, that will reduce the mammoth profits the banks have been making the past several years, which were boosted further by the Republicans’ tax reform law. That sharply reduced corporate income tax rates, not just for banks but all companies, although the banks seem to be the biggest beneficiaries. No doubt Waters and her Democrat colleagues have that in their gunsights also.

But that won’t be the end of it.

Don’t be surprised if Waters and her fellow Democrats start targeting the Fed for steadily raising interest rates over the past several years. That program has pushed the average rate on a 30-year mortgage past 5%, which is not particularly high by historical standards but looks like nose-bleed territory to consumers who have become accustomed to rates well below 4% pretty much for the past 10 years. That’s certainly been high enough to kill off mortgage refinancings and pushed many prospective homebuyers – most of them young millennials, a key Democrat constituency – out of the market.

How long will it be before Waters and other Democrats in Congress start holding Fed Chair Jerome Powell’s feet to the fire demanding that the Fed stop monetary tightening policies that are preventing American consumers from getting loans to buy homes they deserve?

One of the principal voices in this chorus will probably be newly-reelected Sen. Elizabeth Warren, D-Mass., also not known to be particularly chummy with bankers. And with her sights on the White House in 2020, rest assured the banks and the Fed – and Trump, of course – will be one of her favorite targets. Warren, perhaps we need to be reminded, has a long history of criticizing the Fed from the left while Rand Paul and the president have done so from the right.

Indeed, this scenario will put Waters and Warren in an awkward alliance with the president to put even more pressure on the Fed not to keep raising rates, as Trump has been roundly criticized for doing over the past year. But politics makes strange bedfellows, as the saying goes, so that appearance of siding with the devil probably won’t deter them, as long as they can make political hay out of it.

So where does this scenario leave the Fed, the bond market, and the U.S. economy?

Trump’s loud and public criticism of the Powell Fed’s rate policies has been called “unprecedented,” which of course it hasn’t been – lots of previous presidents have tried to put political pressure on the Fed to do what’s politically expedient for them. Trump’s just been more vocal and persistent about it than most. What will truly be unprecedented is the president and leading members of both houses of Congress doing that at the same time. How will the Fed respond to that kind of pressure?

Will the Fed suddenly start to consider that maybe its recent monetary tightening needs to take a rest for a while to see how that policy is affecting the economy? Many people without a political ax to grind have already suggested that, including some within the Fed itself, because they believe the Fed is over-estimating just how hot inflation really is running.

I’m not suggesting that’s the right policy path for the Fed to follow, just one that bears thinking about.

Of course, the equity markets would love for that to happen. It wouldn’t be bad for bonds either. Such a scenario might lead the Fed somewhere it doesn’t want to go, namely having to slam the brakes on runaway inflation down the road by raising rates more sharply and more quickly than it had planned on, which will also likely slam the brakes on the economic boom, if not actually forcing it into recession. And as history tells us, nothing is better than a recession if you want rising bond prices and low yields.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.