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Trump's Budgets Will Suffer a Double Whammy Thanks to Fed Policy

Trump's Budgets Will Suffer a Double Whammy Thanks to Fed Policy
(Dollar Photo Club)

Wednesday, 24 May 2017 07:57 AM

President Donald Trump won’t inherit the same windfall that the Federal Reserve handed the Obama administration each year, and his budget shows he knows it.

The Fed is lifting interest rates and plans to start shrinking its $4.5 trillion balance sheet later this year, two policies that will be a drag on the U.S. federal budget. Higher rates mean that America has to pay more to borrow, and the combination of more elevated rates and a smaller balance sheet will leave the Fed with lower excess earnings, which it pays back to the Treasury.

The double whammy is reflected in the president’s proposed budget and projections, released this week. Trump’s administration sees Fed remittances falling from $116 billion in fiscal year 2016 to a low of $50 billion in 2020 before rebounding. Given the administration’s proposals, the budget also projects that net interest outlays will climb from $240 billion last fiscal year to $428 billion by 2020 as rates increase.

“It’s the price you pay for a good economy,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington and former Fed board official.

The Fed lifted interest rates once in 2015, again in 2016 and most recently in March. Minutes from policy maker’s May meeting, set for release at 2 p.m. Wednesday in Washington, will probably underline that officials anticipate two more 25-basis-point increases in 2017 and plan on starting to wind down Treasury and mortgage-backed security holdings before year end.

Those changes are coming thanks to a strong economy: The Fed is closing in on its goals of maximum employment and stable inflation near 2 percent. That momentum also means that the administration’s budgets will enjoy higher tax receipts than the Obama administration saw.

Zero Rates

“The Obama regime benefited from the fact that we had zero or near-zero fed rates throughout his term,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC in New York. “You have to put ‘benefited’ in quotation marks, because it was an indication that the economy wasn’t doing well.”

Stanley expects Fed remittances to fall by $10 billion per year over the next several years, but he thinks that it’s possible that they could drop even faster. There are two reasons why the Fed’s surplus earnings are about to shrink: It will earn less on its holdings as maturing assets roll off, and the central bank will pay banks higher interest on excess reserves as rates move up.

Falling remittances are expected and probably won’t expose the Fed to a lot of congressional criticism. Central bankers would have more to worry about if they have to lift rates higher than they expect and are forced to pay more on excess reserves than they’re earning.

Earnings could also dip into negative territory if quickly rising inflation spurred the Fed to shrink its balance sheet faster, selling assets at a loss. In either case, the Fed would stop paying remittances to the Treasury until returns rebounded.

“That’s not the most likely scenario; it’s a tail-risk type of scenario,” Stanley said.

Still, Raymond Stone warned in a research note that if losses were to materialize, they “could become a political ‘hot potato’ inviting unwanted congressional intrusion, compromising Fed independence.”

Stone, who is managing director at Stone & McCarthy Research Associates in Princeton, New Jersey, worries central bankers would be hesitant to raise rates to offset inflation if doing so would force them to stop turning over remittances to the government.

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Remittances to the Treasury will decline just as rates rise; Obama-era Fed budget boosters came alongside down economy
trump, budget, fed, whammy
Wednesday, 24 May 2017 07:57 AM
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