Economists are forecasting that the Fed will raise rates by a quarter-point in December and then will boost rates two more times in 2017. Janet Yellen stressed in her testimony to Congress on Thursday (November 17) that the slow recovery and absence of inflation pressures should allow the Fed to move gradually in raising the federal funds rate. Despite these increases, economists do not expect a steeper spike as the fundamentals currently are holding steady.  Also, the Federal Reserve has consistently stated that any increase in rates will be “gradual” and overall rates will still remain among the lowest they’ve ever been.

Yeah, but That Trumpflation Factor

Trump has described himself as “a low-interest-rate person.” As a real estate investor, he relied heavily on other people’s money. He also has promised to deliver stronger economic growth, a goal that could be inhibited by higher interest rates.   Before and since Election Day, Donald Trump has said his first priorities would be to stimulate the U.S. economy by spending big on infrastructure and cutting taxes.

Call it Trumpflation—massive infrastructure spending and tax cuts that will lead to inflation. If Trump has his way with the border wall policies and immigration policies, that would reduce the supply of low cost labor, and there is no doubt that inflation and higher interest rates would follow that, too.  And, if Trump’s $550 billion transportation and infrastructure plan creates jobs and boosts wages, it should lead to greater housing demand and prices.

The concern is that all of this will prompt Federal Reserve to start raising interest rates to combat the resulting inflation.  The immediate impact of higher interest rates would likely be negative for real estate values, because higher cost debt reduces equity returns. Technically, buyers will hesitate somewhat and houses will take longer to sell.   Over the longer term, however, inflation increases the value of hard assets and drives up rents, which increases property values. In an inflationary environment, investors derive most of their return on real estate from appreciation, not from cash flow.

Trump’s intentions are unclear in part because there is a tension between his personal preferences and his political commitments. He is a borrower who now heads the political party that has long represented the interests of lenders.  Trump and other Republicans have attacked Yellen and other federal bank regulators for imposing “overly restrictive” rules on banks, pledging that they will seek to repeal major parts of Dodd-Frank.  And Republicans could take steps to create new oversight of the Fed. Trump can fill a majority of the Fed’s seven-member board with his own nominees over the next 18 months, including replacing Yellen in February 2018. He also could work with Congress on new constraints, including some form of an old idea on the right that a formula should dictate the Fed’s movements of interest rates.  The idea of an audit would provide a way for Congress to review the Fed’s policy decisions.

Ultimately, we should see interest rates rising slightly and holding fairly steady through most of 2017.  By 2018, the combination of Trump’s infrastructure spending, deregulation, and immigration policies, along with his preference for lower interest rates from the Fed and his desire to influence the Fed, should cause a sharp spike in inflation, while his defense spending and tax cuts will drive up deficits, which will be harder for the treasury to fund with low interest rates.  By then, though, we will be facing another crisis that will overshadow all of this like a carnival side show.