Janet Yellen, then Federal Reserve chair, speaks during a news conference following the Federal Open Market Committee meeting in Washington on December 13, 2017. Photo: AP
David Brown
David Brown

What does Janet Yellen as Treasury secretary mean for the US economy?

  • Given that Yellen has been chair of the Federal Reserve, US fiscal and monetary policy are likely to be much more in sync
  • While Yellen is not an advocate of austerity policies, if the market appetite for risk skyrockets or the dollar weakens considerably, higher interest rates might come sooner than expected

Next year will be transformative for the global economy, policy perceptions and financial markets as the world finally transcends the Covid-19 pandemic. Interest rates are already bottoming out, and the US might be in the vanguard for rate rearmament a lot sooner than expected.

Global monetary insurance has succeeded, world growth is springing back and interest rate policy looks too loose. Ultra-low rates can’t last forever and at some stage the great monetary rewind will begin. Latent inflation risks are rising, long bond yields are pressing higher, and rotation trades out of safe-haven government bonds into higher beta stocks have already kicked off.

Irrational exuberance has done its job, risk-aversion is receding and a return to better times might tempt global policymakers to talk tough again in 2021. Premature tightening should be resisted at all costs.

The US should be at the epicentre of global recovery efforts, with future domestic policymaking promising to be much more constructive than the previous four years of gnawing policy frictions between US President Donald Trump and the Federal Reserve. Working relations between US president-elect Joe Biden and the American central bank should be far more harmonious, considering Biden’s pick of Janet Yellen as the next US Treasury secretary.

It’s an exciting move since Yellen preceded current Fed chair Jerome Powell as central bank head, proving a unique opportunity for US fiscal and monetary policy to work much more closely to the economy’s advantage. There’s a better chance now that Biden’s recently unveiled US$7 trillion coronavirus recovery package can rescue the US economy from its deepest recession since the Great Depression.

US President Donald Trump hands over the podium to Jerome Powell after announcing him as his nominee for Federal Reserve chair in the Rose Garden of the White House in Washington on November 2, 2017. Powell succeeded Janet Yellen as chair of the US central bank. Photo: EPA-EFE

The good news about Yellen is that she is not an advocate of austerity policies and has spoken about the need for the government to extend “extraordinary fiscal support” during the pandemic. The aim of Biden’s Build Back Better economic recovery package is sustainable recovery, funding new job creation, boosting consumer spending power with a doubling of the national minimum wage to US$15 an hour, while investing in new infrastructure initiatives to boost economic regeneration.

What this means will be bigger budget deficits and a mushrooming pile of US government debt in the next few years, which must be supported by the Fed’s ongoing asset-buying programme until stronger recovery is secured.

From the Fed’s perspective, it means the policy baton passes from monetary stimulus to fiscal reflation as the main driver of recovery going forwards. This should provide the Fed with a lot more room for manoeuvre on its future interest rate decisions.

In recent months, the Fed has hinted at a strong reluctance to let short-term interest rates drop into negative territory, implying that the target rate for Fed funds has reached a natural floor at the current range of 0 to 0.25 per cent. If the US economy is shifting into a quicker recovery phase, the key question is how long before the Fed eventually shifts from ultra-easing mode back towards a tightening bias?

There is a lot to take into consideration, not least juggling expectations about the future outlook for growth, jobs and inflation, especially while the Fed tries to rebuild its overstretched monetary credibility. Back in June, when the Fed was forecasting that US gross domestic product might bounce back to the tune of 5 per cent in 2021, the indications were that the Fed intended to keep rates steady at zero at least through 2023.

This prospect seems even more likely considering the Fed has downgraded its growth expectations for 2021 to 4 per cent according to September’s Federal Open Market Committee projections. Forward implied rates in the US money market curve seem well contained for now.

Despite Covid-19 vaccine hope, US must expect a winter of despair

It might be another matter if the appetite for risk starts to skyrocket, and the Fed is criticised for force-feeding the market frenzy. The weaker dollar is an issue too, especially if it starts to unsettle imported inflation expectations and upsets major trading partners like China and Europe by undercutting their export competitiveness. Remember that Democrat administrations tend to favour a stronger dollar mantra over benign neglect of the currency. The Fed might opt for higher interest rates sooner than expected just to iron out the glitches.

It might be the last thing on the market’s mind right now, but never say never again to an early interest rate hike from the Fed.

David Brown is the chief executive of New View Economics

This article appeared in the South China Morning Post print edition as: Yellen pick is a chance to sync US monetary and fiscal policy