Central banks don't like to talk politics, so it's no surprise that the U.S. Federal Reserve's stand-pat interest rate decision Wednesday made no mention of the U.S. presidential election. But the shadow of Donald Trump is all over the Fed's wait-and-see stance on a rate hike.
The Fed's policy-setting federal open-market committee (FOMC) held the benchmark federal funds rate steady in the 0.25-to-0.5-per-cent range, despite evidence of a steadily improving U.S. economy that the financial markets still expect will trigger a quarter-percentage-point rate hike at the FOMC's next meeting in December. Indeed, the FOMC's statement acknowledged that "the case for an increase in the federal funds rate has continued to strengthen" – suggesting it has inched closer to that much-anticipated increase.
But the one thing the Fed didn't do is change its message about the timing of a hike – something it did very clearly the last time it raised rates.
Last year, in the late-October rate decision that immediately preceded December's quarter-percentage-point rate hike, the Fed went from talking about considering "how long to maintain its target range [for the federal funds rate]" to "whether it will be appropriate to raise the target range at its next meeting." Central banks will never come right out and say "we want to raise rates next meeting," but the Fed's wording telegraphed exactly that.
But this time, with markets again widely believing that the Fed is gearing up for another December hike, the rate statement was considerably less committal. It merely repeated its past language about looking at various factors "in determining the timing and size of future adjustments to the target range." And in reference to the continued strengthening of the case for a hike, it repeated what it had said in its previous decision in September – that it "decided, for the time being, to wait for some further evidence of continued progress" in job growth and inflation, the Fed's mandated policy focuses.
And, notably, one of the three FOMC voting members who had previously voted for a hike – Eric Rosengren, president of the Federal Reserve Bank of Boston – switched his vote in favour of standing pat on the rate. The overall voting actually took a step further away from a hike, rather than closer.
We'll have to wait for the Fed to release the minutes of this FOMC meeting, three weeks from now, to know why the Fed is being less definitive this time around about the prospects for a rate increase, and what changed Mr. Rosengren's position. But what's clear is that on the economic developments alone, the case for a rate hike has only gotten stronger since September.
The elephant in the Fed's room is the political risk to the Fed's outlook, which has very quickly risen to a fever pitch.
Several new polls have put controversial Republican nominee Donald Trump and the Democratic nominee, Hillary Clinton, in a virtual tie for popular vote, less than a week before election day. Most polls broken down to the state level still suggest Ms. Clinton will win the electoral college, the state-by-state system used for determining the election winner; but an election that a few weeks ago looked like a slam-dunk for Ms. Clinton has suddenly become much tighter – and with the late momentum in Mr. Trump's favour.
Few presidential candidates in history have been considered as big a risk to the U.S. economic status quo as the impulsive and unpredictable Mr. Trump. A Trump win would cast the U.S. economic outlook into considerable uncertainty; it would certainly fuel turmoil in financial markets.
In short, a Trump victory would easily be enough for the Fed to pull a rate hike off the table for December – if not longer. That being the case, it makes no sense for it to signal more strongly to the market that the hike is favoured for December.
Consider that when Britain's Brexit referendum last June resulted in a surprise vote in favour of that country leaving the European Union, the Bank of England was forced to provide liquidity to financial markets and cut its key interest rate in short order, in order to stabilize markets and calm economic fears. A Trump win would, arguably, be a much bigger deal to the economy and markets, not just in the United States but worldwide, than the Brexit vote. It's no stretch to imagine the Fed leaning toward a cut, rather than a hike, following a Trump victory.
The markets, for their part, seem pretty convinced that Ms. Clinton will prevail, and the Fed will follow through on the December rate hike that, for now, the central bank dare not talk about. Though U.S. stocks have gone on a losing streak as Mr. Trump has risen in the polls in the past few days, the losses have been relatively mild – looking more like a bit of pre-vote defence than fear. The bond market is now putting the odds of a December Fed hike at 78 per cent, up from 68 per cent before Wednesday's rate announcement.
All that's standing in the way is Mr. Trump. But the guy has a knack for filling a doorway.