Monetary Policy Is Important, But US Fiscal Stance Moving Center Stage

The Federal Reserve hiked rates in March. Whatever gradual hikes mean, it seems to preclude moves in back-to-back meetings. There are two chances of a May hike:  Slim and none and Slim left town.  

June is a different story.  Anticipating the economy finding better traction, and a non-disruptive conclusion of the French presidential election, we continue to think a June hike is the most likely scenario. Bloomberg’s calculation puts the odds of a June hike near 47% down from closer to 56% a week ago. The CME puts the chances at nearly 55%, down from 59% at the end of last week. So far this week, the implied yield on the June Fed funds futures contract has risen 1.5 bp to 97 bp.  

The focus may shift back to fiscal policy. There are two large outstanding issues. The debt ceiling, which was reinstated March 15. The second is spending authority, which expires near the end of the month, just ahead of Trump’s 100th day as President.  

The imposition of the debt ceiling forces the US Treasury to take extraordinary measures. An analyst who previously worked at the Federal Reserve suggests that among the measures are the boosting of cash balances, which in turn drains the excess reserves and is one of the factors that have boosted the cross-currency basis. This, in turn, is a drag on the US dollar.  

Often the increase in the debt ceiling, which allows the US government to pay for what it was authorized to spend is a source of negotiation with Congress. Many people thought that with one party in control of both the legislative and executive branches, that this would not be a battle this time. However, as we have seen (e.g. health care reform), the Republican Party, like all modern parties, are a coalition of disparate interest.   

It has been the legislative branch (the House of Representatives) that uses the debt ceiling to extract concessions from the President, but this time, it appears that the executive branch may threaten Congress with it. Director of the Office of Management and Budget Mulvaney, one of the founders of the Freedom Caucus (formerly known as the Tea Party) has been talking about prioritizing debt servicing this week.