Fiscal Policy Uncertainty, Offsets, Scoring and Monetary Policy Inflections

Tax reform, trade policy, defense spending, deregulation, healthcare reform and infrastructure spending are all potential positives for the U.S. economy in 2017 and 2018. Until the Trump Administration unveils its plans through this spring and summer, and proves its ability to implement its plans, we will endure a high degree of policy uncertainty. Indeed, the Economic Policy Uncertainty Index, which was useful in tracking policy uncertainty during and immediately after the Great Recession, is again elevated. Policy uncertainty through the Great Recession was accompanied by a fear of how bad things could get. Now, elevated uncertainty is not associated with a fear of dropping into an abyss, so it is not paralyzing. Rather, it simply reflects the magnitude of the changes that the Trump Administration is attempting.

Many of the proposed policy changes are big economic levers that have the potential to move the U.S. economy in a positive direction in the short-term, and at the same time move the federal deficit in a negative direction over the long-term. According to the projections of the Congressional Budget Office, we were already facing a growing federal deficit before President Trump took office. Given the highly constrained federal budget deficit outlook, every Trump Administration policy proposal is accompanied by a discussion of budget offsets. In the case of the proposed 10 percent increase in federal defense spending, the offset would be similar reductions in federal nondefense discretionary spending in order for the plan to be deficit-neutral. The Congressional Budget Office is expected to release its review of the American Health Care Act this week. The CBO’s budget scoring will shape the political debate about the need for offsets due to the proposed changes in healthcare policy.

Another potential offset to proposed fiscal changes is the so-called “monetary offset.” The Federal Reserve now appears to be on the verge of another interest rate increase, expected to be announced on Wednesday, March 15. Given the strong jobs report for February, when 235,000 net new jobs were added to the U.S. economy, we see no roadblocks to the Fed’s third rate hike in this tightening cycle. The first came in December 2015, the second came a year later, in December 2016. Now just three months later Fed interest rate policy is at a new inflection point. We look for the Fed to raise the fed funds rate range by 25 basis points this week, and do it again at least two more times this year, accelerating from the once-a-year pace of 2015 and 2016. In addition to the monetary policy statement on March 15, the Fed will issue a new “dot plot.” It will be interesting to see if the implied trajectory of future rate hikes lifts with the new dot plot, compared to the previous dot plot released last December. We think there is a reasonable chance that the March dot plot will steepen slightly, implying four rate hikes this year instead of the currently expected three. Gradually climbing interest rates may prove to be an “offset” to Trump Administration fiscal initiatives, including the discussed, but not yet defined, trillion dollar infrastructure program.

As Fed policy hits a new inflection point, we see hints that other central banks may also be at inflection points in their policies. Last week Mario Draghi, President of the European Central Bank, suggested that ECB policy has turned the corner, away from more monetary easing and toward a discussion of the gradual removal of accommodation.

For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here: US_Economic_Outlook_0317.


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