Secretary Mnuchin fires the first shot

The Federal Reserve

Last night, Secretary of the Treasury Steve Mnuchin had some rather interesting things to say about inflation: “There are a lot of ways to have the economy grow. You can have wage inflation and not necessarily have inflation concerns in general.” This might be true in periods where we have had tremendous leaps forward in productivity. Absent of that, however, this thinking runs counter to traditional economic thought, which is the thought that governs the Fed. While eyebrows were raised and Jeff Gundlach tweeted, “Mnuchin: policies will raise wages without inflation. Yeah, sure,” the bond market seemed not to take much notice. I found this lack of notice a bit curious, since a statement like that from a Treasury secretary, in a time where market participants are taking notice of rising wages and other inflation measures, would normally cause some indigestion on the long end of the yield curve. Maybe the sharp rise in yields we have experienced the last couple of weeks is viewed as enough of a reaction. Maybe it was Friday and people were just tired of selling. Or maybe the market views that the Federal Reserve will aggressively counter a fiscal policy that it sees as too inflationary. I believe in the latter and think a battle is about to be joined between the White House and the Fed.

There are things pretty unique about President Donald Trump. Many people like his unique qualities and many do not. However, one thing that will not be unique to President Trump is that if the Fed engages in a policy to dampen economic growth to guard against corrosive inflation, he will howl like any president would, especially a first-term president with mid-term elections coming up. If we think about the last three Fed Chairmen prior to Jay Powell—Janet Yellen, Ben Bernanke, and Alan Greenspan—they spanned the presidencies of Ronald Reagan, George H.W. Bush, Bill Clinton, George W. Bush, Barack Obama, and now Donald Trump. For the most part, all of these Fed Chairmen operated in an environment of very low inflation as well as economic and financial market credit crises (1987 stock market crash, savings and loan crisis, Asian Contagion-long-term capital crisis, the dot-com crash, September 11th, and the 2008 near-end-of-the world crisis), where they used monetary policy to counteract financial turmoil and recession. Most of the Fed Fund hikes that occurred during this period of over 30 years were done incrementally from 2004 to 2006, 25 basis point increases for 17 meetings in a row. It should be noted that this march from 1% to 5.25% was the most benign removal of monetary stimulus to date. In hindsight, many blame this slow walk by the Greenspan and then Bernanke Feds as one of the reasons we had the credit explosion of 2007-2008. Other than those incremental hikes, all the Fed Chairpersons have been each of these presidents’ best friend, because over this time period, they have been very accommodating with regard to stimulating economic growth with monetary policy.

 

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