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Dangers awaiting Jerome Powell after taking over the Fed

Jerome Powell Donald Trump

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Jerome Powell will take over the Federal Reserve’s leadership against accelerating growth, the lowest unemployment rate since 2000, strong global recovery, and the upsurge in US stock and property markets. The improvement over the conditions in which Janet Yellen took office in 2014 is visible with more than 3.8 million unemployed, wage growth slowed, and interest rates at unprecedented low levels.
The officials, however, outline the risks faced by Powell’s new regime in order to continuously balance weak inflation with the signs that the prosperous economy and markets in the US are at risk of overheating.
On the background of the US government’s incentives in the form of lower taxes and a higher federal budget, as well as asset prices that are starting to look revalued, the question is whether the Fed under Powell would need to be aggressive.
We should not underestimate how dangerous the situation is. The huge tax cuts and a potentially very large increase in costs at a time when the level of unemployment is already very low and inflation is accelerating is largely unprecedented. This moment of the cycle is the most difficult to manage by central bankers.
Powell will lead Fed in a few days. On Wednesday, at the last political meeting of Fed under the manager of Janet Yellen, left monetary policy unchanged. The future Fed Chairman is presented as a successor candidate who feels comfortable with Yellen’s ultra-careful and carefully planned cash-raising program.
The US Central Bank is in the middle of the cycle of interest rate tightening, which actually made the financial conditions more relaxed than when the tightening began at the end of 2015. According to the official outlook for the Fed, three hikes in interest rates are expected, with the next probably in March. This will be coupled with a steady contraction of the central bank’s balance sheet.
Analysts do not expect a sudden change of monetary policy course, but Powell can not keep things in the Fed on an autopilot for too long. The key issue, however, is how strongly we see this combination of higher asset prices and lower tax rates with a better economy being reflected in inflation. In the end, Fed may have no choice but to raise interest rates more aggressively.
The representatives of the Fed are already suggesting the difficult decisions ahead. New York Federal Reserve Chairman Bill Dudley said this month that the central bank’s history of developing a “soft landing” for the economy, when unemployment is too low, is not rich.
“If we grow above the trend in 2018, the unemployment rate is likely to drop even below 4%”, said Bill Dudley. “In this environment, the risk, not in 2018, but in the long run, is that the economy may actually overheat that inflation may not stop at 2%, or 2.1%, or 2.2%, and then the Federal Reserve will have to hit the brakes a little bit harder”, added he.
The US Federal Reserve is currently aware that the recent economic cycles ended with the ups and downs of the financial markets – yet the central bank believes its ability to curb rising asset prices is limited. Although central bankers are generally trying to sound optimistic about the financial markets in recent months, the discussions will get worse if stocks rise further in the coming months.
Jerome Powell also faces big questions about how the Fed will react if the markets or wider economy reach the buffers. The federal government may be targeting an annual deficit of 1 trillion USD in the coming year, which means that there will be less fiscal power to cope with the next recession.
However, at low levels of neutral interest, the Fed’s ability to lower interest rates may not be great. Among the main debates in the program were whether the central bank had to adjust its inflation target in order to accumulate additional ammunition to combat recessions.
The new leaders of the Fed may be confused by the speed at which America’s wealth can change. Alan Greenspan, for example, faced a stock market crash just two months after lead Fed in 1987. And just one year after Ben Bernanke became governor in 2006, the United States was on the verge of a financial crisis.
The moderate conditions that are present in the forthcoming transfer of power may not last for a long time.