A central focus of the Trump administration has been to reduce the U.S. trade deficit and to force our trading partners – mostly China – to eliminate what he claims to be unfair trade practices. Yet former Fed Chair Janet Yellen doesn’t understand what Trump is doing.
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“I don’t understand Trump’s priorities with respect to trade,” she said.
Yellen was the chair of the Fed from 2014 to 2018, overlapping both the Obama and Trump presidencies. She is now a distinguished fellow in residence at the Brookings Institution, a Washington, D.C.-based think tank.
She was a keynote speaker at the Schwab IMPACT conference on October 30 in Washington.
I’ll come back to Yellen’s thoughts on President Trump, but first let’s review what she said about the capital markets, the economy and monetary policy.
Putting the market volatility in context
Recent market volatility is a response to a number of uncertainties, according to Yellen, including trade relations with China, which affect the global economic outlook. The market is trying to figure out where rates are heading, she said, particularly in the long term. “Movements in rates have a significant effect on stocks,” Yellen said.
Even with the recent correction, the market’s P/E and Shiller CAPE ratios are still “quite high by historical standards,” she said.
But stocks are not patently overvalued, according to Yellen. Given that rates are still low and will normalize at a lower-than-average level, higher valuations can be justified.
If the economic expansion continues through July, she said, it will be the longest in American history. But is a recession imminent?
U.S. recessions are usually due to excesses, she said, like in housing prior to the financial crisis and in tech stocks prior to the dot-com collapse. “I am worried about the buildup in debt in the non-financial sector,” she said, but there are no buildups in other parts of the economy that concern her.
Most importantly, she said there are no financial trends that “spell the end of a long expansion.”
Even though unemployment is at its lowest level in 50 years, there is still a danger that the economy could overheat, according to Yellen. The Fed is trying to move to a more neutral position to avoid that overheating while maintaining growth.
She has confidence in her successor, Jerome Powell. “The Fed can slow and stabilize the economy slowly and thoughtfully,” she said.
“But it could still cause a recession,” Yellen said.
There has been a correction in the market but financial conditions are still accommodative. At least a couple more interest rate increases are going to be necessary to stabilize growth and employment, according to Yellen.
Prior to the crisis, the thinking was that 2% was the “normal” real interest rate, Yellen said. But as other economic trends emerged – slowing productivity rates, a high demand for safe assets and an aging population – the normal level of real rates is likely to “be low and stay low,” she said. A real short-term rate of 1% is realistic, she said, with inflation at 2%.
The Fed funds rate may need to go above 3% because the economy “needs restraining,” Yellen said. She cited a number of data points that justified her forecast of higher short-term rates. When you look at the job market, there is a high ratio of job openings to unemployed people. Firms are having difficulty hiring based on survey data. Household perceptions of the job market show that people believe it is very tight and hard for firms to hire. “That should drive up wage and price inflation,” she said.
“If the labor market continues to tighten,” she said, “then inflation could pick up beyond its 2% target and force the Fed to be more restrictive.”
Why not let inflation run higher than 2%? According to Yellen, the Fed needs to be forward-looking and proactive to prevent runaway inflation. If not, she said, inflationary expectations could become a self-fulfilling prophesy and accelerate price increases. “The Fed does not want to tighten to a level that would cause a significant recession.”
“The Fed should sustain the good conditions and avoid getting too far behind the curve,” Yellen said.
Read the full article here by Robert Huebscher, Advisor Perspectives
