Fed likely to go ahead with rate hikes despite Trump turmoil

[WASHINGTON] The political brouhaha in Washington looks unlikely to blow the Federal Reserve off course from raising interest rates further in 2017, starting with an increase next month and following up with another later in the year.

Fed watchers said the central bank will press ahead with plans to gradually normalise rates in order to rein in an economy that officials believe is growing above its potential and prevent an already-stretched labour market from becoming even tauter.

"Unlike in 2015 and 2016, the Fed has made pretty clear that it's on a trajectory of tightening rates that will not likely be derailed," said Jonathan Wright, a former central bank economist who's now a professor at Johns Hopkins University.

Policy makers in March penciled in two more rate hikes for this year after raising them for the third time since the end of 2015. They next meet on June 13-14, when they'll update their forecasts for the economy and interest rates.

Traders in the money market put the odds of a rate rise next month at about 65 per cent, down from 85 per cent on May 9. They also lowered the probability of a third hike this year to well below 50 per cent.

Major US stock indexes recouped a bit of their losses on Thursday after suffering their biggest declines in eight months the day before on dimming hopes that a politically-wounded President Donald Trump will be able to push through big cuts in taxes.

Cleveland Fed President Loretta Mester said Thursday that financial-market volatility has not affected her economic outlook.

"You have to look through those temporary fluctuations in both economic and financial data and focus on what the implications are for the medium-run outlook," she told reporters after a speech in Minneapolis.

Fiscal Policy

Fed officials have been cautious about building expectations of a fiscal policy-induced bump in economic growth into their forecasts and so may not be as worried as investors by its apparent fading prospects.

About half of policy makers didn't incorporate explicit assumptions about fiscal policy during their last forecasting round in March, according to the minutes of that gathering. And of those that did, several pushed back their expectations of a "meaningful" budget boost until 2018.

Officials in March projected that the economy would grow 2.1 per cent both this year and next, above their 1.8 per cent estimate of its long-run cruising speed. They also reckoned that a 4.7 per cent jobless rate was equivalent to full employment. Unemployment in April was 4.4 per cent.

On Course

"If the economy still looks like it's going along at 2 per cent-plus and the labour market continues to tighten, I don't see any reason for them to be deflected from the course they've been on," said Peter Hooper, a former Fed official who is now chief economist at Deutsche Bank Securities Inc.

A major drop in the stock market and a big reversal in consumer and business confidence could change that, though for now that doesn't seem likely, he added.

Indeed, the Fed might even welcome some cooling off of what until recently had been a record high stock market, said Thomas Simons, a senior economist at Jefferies LLC.

Some Fed officials in March "viewed equity prices as quite high relative to standard valuation measures," according to the minutes released by the central bank.

Michael Feroli, chief US economist at JPMorgan Chase & Co, said the course of inflation over the coming months will be more important in shaping the Fed's plans than the political tumult in Washington.

Consumer-price inflation has slowed more than forecast in the last couple of months, raising questions about whether the Fed remains on track to achieve its 2 per cent inflation target.

Mr Feroli said the fundamentals point to inflation resuming its upward trend, with import and unit labour costs rising and the US dollar falling.

As a result, he expects the Fed "to look past" the recent weakness in prices and raise interest rates again next month.

Besides, policy makers don't want to be seen as changing their plans in response to the turmoil surrounding Mr Trump.

"They're trying to lower their political profile, not raise it," Mr Feroli said.

BLOOMBERG