US: Janet and Don, Rate squeeze and fiscal ease - BNPP

The latest FOMC press conference left a feeling that the US Federal Reserve is not impressed at the prospect of fiscal easing, viewing it as too late in the cycle and unlikely to add much to long-term GDP, while risking an inflation overshoot and an unemployment rate undershoot as noted by the analysts at BNP Paribas. 

Key Quotes

“Our economic forecasts were revised up substantially following the election result (see Global outlook: Everything changes). But we also revised up our Fed rate forecast, and our bond and USD FX forecasts. Thus the question we ask is: to what extent will a US Fed squeeze in monetary and financial conditions completely offset or neutralize President-elect Donald Trump’s fiscal ease?”

“Our assessment seems pretty much like the Fed’s, if Chair Yellen’s December press conference is any guide: fiscal stimulus at the top of the cycle will have modest longer-run effects on GDP and potentially big effects on monetary policy. Our view is that Mr Trump’s policies, unless they change productivity significantly, will change the long-run composition of GDP – probably in a way that disadvantages net trade and manufacturing while leaving the long-run level of GDP not much different from what it would have been before. The big effect will be on the level of interest rates and the level of the exchange rate at which this take place, as well as the size of the fiscal deficit that accompanies these rates.”

“Mrs Yellen essentially said that Trump’s fiscal stimulus is not needed from a macro-economic standpoint. It will give a higher government deficit and higher Fed funds rates, but ultimately, unless the supply side is boosted, long-run GDP will not be affected, though the shorter-term trajectory may become more volatile. We tend to agree.”