I’m sure this is abundantly clear to most people, but in case it’s not, allow us to reiterate: piling fiscal stimulus on top of an economy that’s already running hot and then throwing in an unfunded tax cut for “good” measure is likely to end in tears.
This dynamic is one of the main drivers of the bond selloff that’s sent 10Y yields to four-year highs. If there were already worries about the possibility that a sudden uptick in inflation pressures could force central banks to hike aggressively for fear of falling too far behind, what Trump is doing is exacerbating those fears.
Long story short, this has the potential to short-circuit the “Goldilocks” environment by transforming “slow and steady” into “rapid and batshit” – or maybe “rabid badger” is more fun if you like crappy alliteration.
Next up will be higher deficits and rate hikes and tighter financial conditions and that’s obviously dangerous for markets, especially in light of stretched valuations and how accustomed everyone has become to well-anchored inflation and steady but not blockbuster growth.
Well sure enough, Credit Suisse is out on Monday calling for four Fed hikes in 2018 up from three which was their forecast as late as Friday afternoon.
“US and global growth are both near momentum peaks, making this stimulus poorly-timed from a macro perspective (especially in the wake of large tax cuts passed just several weeks ago),” the bank’s James Sweeney writes, before noting that while in the short-term, this is indeed likely to boost growth, in the long-term it could prove ill-advised. Here’s Sweeney on the Fed:
We now expect the Fed to hike rates four times this year (our previous forecast assumed they would pause in Q4). The FOMC has already boosted their growth outlook for 2018 in light of the tax bill passed in December and we anticipate another upward revision to their growth forecast at the March meeting. With the economy near (or above) full employment, prudent risk management suggests the Fed ought to accelerate their tightening in response to a large positive demand shock. It would not surprise us to see the FOMC’s rate projections (dots) move higher in the March SEP.
He goes on to detail how the stimulus is likely to play out, but the bottom line is that “increased treasury supply is likely to lead to some market – driven tightening of financial conditions, even beyond the faster pace of Fed rate hikes [while] tighter financial conditions and larger deficits imply rising debt service costs for the US government, and worsen the long -term US debt dynamics.” Here’s the deficit projection:
To be clear, this was always the danger. The “new normal” is entirely inconsistent with Trump’s “MAGA” message because that message explicitly promises something “better” and “bigly-er” than what we’ve seen in the recent past, which means he’s going to chase that dream no matter what anyone tells him about the likely consequences.
Don’t say you weren’t warned.