Bloomberg is reporting this week that the new administration is considering the first major federal tax hike since 1993 as it works to design its long-term economic program.
Unlike the $1.9 trillion COVID-19 stimulus act, the next initiative, which is expected to be even bigger, won't rely just on government debt as a funding source. In fact, it has been increasingly clear for some time that tax hikes will be a component. Treasury Secretary Janet Yellen has said at least part of the next bill will have to be paid for. Key advisers are now making preparations for a package of measures that could include an increase in both the corporate tax rate and the individual rate for high earners.
The result is increasing pressure on officials like Federal Reserve Chair Jerome Powell who will be required to “defend his ultra-easy monetary policy outlook amid a quickening economic recovery that's ignited fears of inflation,” Bloomberg says.
The Fed is wrapping up a two-day policy meeting this week, almost exactly 12 months after slashing interest rates to nearly zero as COVID-19 spread. It will publish its policy statement and quarterly forecasts at midweek and the chair is expected to hold a press conference the same day.
A lot has changed in the three months since the Fed last published economic projections, Bloomberg notes, including passage of the massive fiscal stimulus and accelerating vaccinations. Powell's spent recent weeks trying to dispel premonitions about impending tightening and he'll be asked to reconcile a likely upgrade to the Fed's economic outlook and its projections that are expected to show zero interest rates through 2023.
“I think this is the kind of meeting the Fed would rather not have,” said Ethan Harris, Bank of America Corp.'s head of global economic research. “the big problem that they face is that they have to raise their forecasts — the GDP forecast they have right now is so stale it could be carbon-dated.”
The Fed last updated its projections in mid-December before broad distribution of vaccines and almost $3 trillion in fiscal aid was signed into law.
Economists surveyed by Bloomberg expect Fed officials to upgrade their 2021 economic-growth forecast to a median 5.8% from 4.2%. That's still below some of the most bullish Wall Street estimates, the report said.
Goldman Sachs Group Inc. is calling for a 7.7% increase in the same period and 11 other firms tracked by Bloomberg say growth will be at or above 7% at the end of the year.
The better outlook has raised market expectations for future inflation and prompted investors to sell bonds, pushing up yields and renewing skepticism that Powell can keep rates low for as long as the Fed has indicated.
But the Fed chief is sticking to his guns, arguing that the economy has a long way to go in fully getting back to where it was before the pandemic. He's reiterated that the central bank's new policy strategy means it will focus more intently on returning to maximum employment, and will judge that in a much broader way than before.
Although 75% of economists in Bloomberg's recent survey said the Fed will have to raise rates “before long,” they didn't see a change to the Fed's median 2023 projection at this month's meeting. Interest-rate futures, however, are pricing in about three 25 basis point rate increases before the end of that year.
Recovery optimism reflects a sense that activity will bounce back quickly in the second half of the year. Hiring has already picked up, with more than half a million jobs created in the first two months of 2021 and some see that improvement accelerating. But as Powell pointed out earlier this month, nearly 10 million Americans remain jobless. The Black unemployment rate rose to a staggering 9.9% last month.
Inflation also hasn't reflected much of a recovery yet. Stripping out more-volatile food and energy prices, the consumer price index edged up 1.3% in February, far from the Fed's 2% target. Economists expect bigger gains in the coming months, both due to transitory pandemic-related effects and things like higher gas prices and increased spending on leisure activities following a year of lockdowns.
Powell last year unveiled a new policy framework, saying they'll allow inflation to overshoot 2% after periods below it. That'll likely mean the Fed will keep policy accommodative for longer.
But if the quick and powerful recovery that bond traders are betting on materializes, it could cause a more disorderly sell off in Treasuries, threatening stable financial conditions, which the Fed wants to avoid.
In the meantime, Powell and his colleagues have indicated they're not worried about the recent rise in Treasury yields, saying that as long as such price moves are driven by the right reasons — such as the stronger economic outlook — it's not a concern.
So, we will see. Clearly, the new administration has large ambitions for new programs leading many to look for evidence of new inflation — a potential development producers should monitor closely as the season progresses, Washington Insider believes.