Fed Minutes & American Demographics

When the Fed raised rates in December, I explained it was because of the added inflation the Trump election brought and the anticipated stimulus package in 2017. The media and the Fed seemed to discount these factors to not appeal political. Those who disagreed with me said the Fed was going to raise rates after the election anyway. They try to act ambivalent to any political factors. My point is not a political one either. The Fed would have raised rates if a Clinton win brought inflation and a potential stimulus. The key is not who won, but what the effect the election had on markets. Now we know from the latest Fed minutes on Wednesday that the Fed did consider fiscal stimulus in 2017 when deciding to raise rates. They didn’t mention Trump by name, but CNBC is reporting it as being motivated by the President-Elect.

The Fed has been dependent on equity markets. It didn’t raise rates in the fall because the market was selling off after any hawkish statement. The Fed was given the green light to raise rates in December 2015 as stocks rallied into the meeting. They then fell last January which is why the Fed halted its increase schedule. The market once again gave the Fed the greenlight last month as the Trump rally gained steam. Considering the market has tracked the Fed’s balance sheet throughout the bull market up until the Trump election, I would say the hope coming out of this election is this first time the market was driven higher by something other than dovish monetary policy.

It has been said that Trump created the inflation the Fed has been trying to create with three rounds of quantitative easing and operation twist. I disagree with inflation being the goal. Inflation is when prices increase. Inflation is not the same thing as growth. The economy needs real GDP growth not nominal GDP growth. The economy needs to increase productivity. It also needs to grow GDP per capita as the demographic trends in America are weak. Increased wages and productivity may increase population growth, but there’s also social changes involved with how many children families have.

The 2016 population growth was 0.7% which is the lowest growth rate since 1937. The median age in America is expected to rise from 38.1 to 42 by 2045. It’s not a huge problem like it is in Japan and China as Japan’s population is in decline and China’s is expected to start declining in 2035. While demographics aren’t as big of an issue in America, it still has a negative effect as there are less younger workers to pay for older retired people’s benefits. At some point in the next 10 years, America has to raise its retirement age to make up for this. The only other way would be to cut benefits on a per year basis.

Believe it or not, millennials are now replacing having children with buying pets according to Jean Twenge who is a psychology professor at San Diego State University. This is because pets are cheaper and because millennials are half as likely to live with a partner than 50 years ago. 75% of Americans in their 30s have a dog, while 50% of the general population has a dog. 51% of Americans in their 30s have a cat, while only 35% of the general population has one. This means GDP growth of above 3% annualized will be even harder to accomplish as time goes on. The main problem with this recovery has been GDP per capita, but the population growth isn’t adding as much to nominal GDP growth as it used to.

The trend away from having children and towards pet ownership has long term investing implications. The kids toys, baby health care products, and children’s apparel firms will be hurt and the pet care companies will be helped. This isn’t a fad because once an adult decides not to have kids in her 30s, her biological clock goes off. These people who don’t have kids will likely be pet owners for the rest of their lives. An interesting point is that marriage and child rearing has been put off a decade from mid-20s to mid-30s. The trend can no longer continue which means those who want to focus on their careers even later in life won’t be able to have kids. This factor could lead to slower population growth rates than expected. I am not old enough to have seen past projections go awry, but as with any projection, it can be wrong.

A final point on population issues is the question on how Trump’s immigration plans will affect its growth. The expectation is for America to take in 1 million migrants per year. As the birth rates have fallen, immigration has become a major factor in population growth. For example, in 1955 the increase in population was 2,596,688 and the net migration was 174,100. However, in 2015 the increase in population was 2,345,156 and the net immigration was 1,001,600. As you can tell, migration matters now more to population growth than in the past. I expect Trump’s policies on immigration to be less extreme than his rhetoric on the campaign trail. He may stand against letting in Syrian refugees, but I expect America to remain a nation that takes in over a million immigrants per year.

Getting back to monetary policy, now that we know fiscal stimulus expectations were involved in the Fed’s decision in December, my previous projections hold more water. I reiterate my point that the Fed won’t raise rates in the first few meetings until it sees what fiscal plans get passed by the newly elected Congress. The market is relying on fiscal stimulus too much in my opinion because the GOP is typically against spending measures and stimulus packages usually happen in recessions.

Conclusion

While I disagree with Fed policy, I usually have a good idea which direction it is leaning in. I remember hearing some Fed watchers claim the anticipation of a stimulus in 2017 didn’t factor into the rate hike decision in December. From the Fed minutes, now we know it was a factor. My estimate for 2017 continues to be zero rate hikes or cuts, but I will be updating this forecast many times this year.

1 Comment

  • Calvin

    January 8, 2017

    According to CME Group, there was approx 95% chance of a December rate hike at least a few weeks prior to the election. It didn't matter who was elected, the rate hike was in.