Since the height of the financial crisis in 2008, the Federal Reserve system has been the primary force behind the market and economic recovery.
By lowering interest rates to almost zero and engaging in a variety of measures such as asset purchase programs and quantitative easing, the Fed has effectively engineered an asset price recovery, lifting corporate profits, home prices and markets without causing significant inflationary pressures. And though the dire scenario of hyper-inflation that some predicted hasn't occurred, the efficacy of monetary policy measures has declined at an accelerated pace to the point that further measures would have little, if not the opposite impact that they have had in the past eight years.
Although this may cause some to be alarmed and worry about the inability of the Fed to act in the event of another crisis or recession, the fact is that this is a positive development.
It may seem hard to believe, and there are plenty of soundbites and indications to the contrary, but the men and women who serve in Congress are actually pretty smart and well informed. The political process is a slow one, and given the construct of our election system, many politicians will opt to do little or nothing until they absolutely have to do something.
As Winston Churchill famously said, "you can always count on the Americans to do the right thing, once they've exhausted all other options."
So, faced with the reality that the Fed will no longer be able to do the heavy lifting for our economy, Congress will have to act. The return of fiscal policy engagement should be welcomed by all as it is high time that we address our spending habits as well as our tax code.
And while it is virtually assured that many won't be pleased with the policy decisions that will be made, those decisions will lay the foundation for a path forward.
Here is what to expect over the coming years:
- Inflation will continue to creep up slowly, allowing the Fed to raise rates at a slow pace. Expect three to four rate increases between now and the end of next year. History shows that markets and the economy perform well during the early stages of rate increase cycles.
- Corporate earnings growth will pick up as global growth increases slightly as well. This should help support and ultimately drive stock prices higher.
- Given the disconnect in fiscal and monetary policies around the globe, expect a continued dollar rally, especially against the euro, pound and yen.
- Expect some form of tax reform, including pressure on corporations to repatriate foreign earnings.
- A change in Social Security taxation and payout schedule is likely.
- New banking regulations designed to reduce the risks of another financial crisis and the too-big-to-fail environment are probably on the way, and this will likely lead to a break up of some banks.
The Fed has done its job, and now Congress must do the same. A slow rise in rates along with fiscal policy reform are necessary and timely.
Should Congress fail, the next recession is likely nearer than most expect.